In the late 1970s, American mortgage rates were on the rise. By the time 1981 rolled around, the interest on a fixed rate, 30-year conventional loans had swelled to an astronomical 13.74%! Needless to say, as loan payments ballooned, the housing market became a challenging arena. For buyers, homes that had previously been affordable were all but out of reach. For sellers, finding a buyer that was able to take on the staggering interest rates involved in financing their purchase seemed impossible. So people got creative.
This was the advent of seller financing.
What Is Seller Financing?
In a nutshell, it’s a D.I.Y. mortgage.
The idea behind seller financing is that instead of getting a mortgage through a bank, buyers finance their purchase directly from their sellers. In this scenario, the buyer signs a promissory note promising to repay their debt to the seller. The seller is just like a bank: they hold the mortgage (or deed of trust, depending on the state), which means that it will be up to the seller to begin foreclosure proceedings in the event that the buyer is unable to make their payments.
The Modern Resurgence of Seller Financing
Seller financing obviously comes with a set of trade-offs, but in a challenging housing market, it may be the best option for many people. And now, in the wake of the 2008 recession, federal regulations (the Dodd-Frank Act) have made it tougher than ever to get a mortgage, and many Americans are once again being forced to resort to seller financing to purchase their homes.
So what are the factors involved in the decision to forgo traditional financing options in favor of seller financing?
The Advantages Of Seller Financing
Advantages for the seller
The seller has the potential to receive payment in the form of a lump sum instead of a series of payments over many years.
The seller has no obligation to spend money fixing up the house before selling it.
The title to the house will remain in the seller’s possession until the buyer has completed their payments. This means that if the buyer defaults, the seller will get to keep the payments that have been made, as well as the house itself.
Sellers can close the deal faster because the mortgage process with banks is completely bypassed.
Advantages for the buyer
Because no bank or government regulations apply, the down payment is flexible and up for negotiation with the seller. Of course, how much of an advantage this is depends on the buyer’s bargaining skills.
The real estate closing will be cheaper because the buyer will not have to pay any bank fees.
If the buyer’s credit is compromised and is preventing them from securing a mortgage, seller financing will be their only option in the short term.
And again, the real estate closing will move much faster with seller financing because no time will be spent waiting for loan applications to clear.
The Drawbacks Of Seller Financing
Drawbacks for the seller
If the buyer stops making payments for any reason, the responsibility of carrying out the foreclosure process will fall on your shoulders.
If there is a foreclosure, and the property ends up back in your possession, there is no telling how well it was maintained while the defaulting buyer was occupying it. You might have some costly repairs to make before it’s ready to be put back on the market again.
If you are selling a large number of homes with seller financing, you may now be required by law to get a bank official involved in the transaction. This means time, money, and red tape, when the whole point of seller financing was to avoid these things in the first place.
Drawbacks for the buyer
Many banks require that mortgages be paid fully before properties can be sold again. If the seller has not finished paying off their own mortgage at the time when they are selling the house, the burden of paying this mortgage may be transferred to the buyer, who will then be forced to produce a large lump sum in order to purchase the house.
Buyers will probably have to pay a higher rate of interest than they would have gotten from the bank. But remember why the buyer is doing this in the first place: they do not qualify for any financing whatsoever from a bank. So, for many people, this is better than nothing.
For buyers, finding a seller who is willing loan to them is not a sure thing. Sellers might side with the banks and opt out of loaning to buyers as well.
If, after a few years, the buyer has to foreclose, they will lose all of the money they have already paid to the buyer, plus the house.
The Role Of Real Estate Lawyers In Seller Financing
No matter what your role in this transaction, you will want to have an experienced real estate lawyer on your side. In addition to being available for consultation, this lawyer will help you by writing or looking over your sale contract, as well as your promissory note.