What is Seller Financing?
Seller financing is a creative lending technique that allows the home buyer to take out a mortgage from the home seller instead of, or in addition to, a traditional bank. Some homeowners use seller financing as an incentive to draw in potential buyers. With seller financing, buyers do not have to meet the traditional lending standards set by Fannie Mae and Freddie Mac. Instead, they only need to meet the qualifications set by the home seller. In many cases, the seller is willing to be flexible in regard to credit score, income, down payment, and other issues.
Types of Seller Financing
There are four main types of seller financing: private party mortgages, seller carry back mortgages, assumable mortgages, and wrap around mortgages.
If the seller owns the property free and clear, he may choose to be the sole lender (private party) by offering a first mortgage. In this case, the buyer takes out a single mortgage through the seller. His monthly payments go directly do the seller, without any bank involvement.
More common is the seller carry back mortgage. A buyer takes out a typical mortgage from a bank as well as a smaller mortgage from the seller. Generally, this second mortgage is used to make up for a buyer’s lack of down payment funds. For example: a buyer may borrow 80% of the home’s purchase price from the bank and 20% from the seller. The bank is the primary lender, but the seller holds a lien on the property until the second mortgage is paid off.
An assumable mortgage is any type of seller financing that involves the retention of the sellers original home loan. This can play out in different ways: the seller may charge the borrower monthly payments or the borrower may take full responsibility for the debt and pay the lender directly.
A fourth option is the wrap around mortgage (which also falls under the umbrella of assumable mortgages). In this instance, the seller maintains his own debt on the property after the sale. The buyer sends the seller monthly mortgage payments. The seller pays his own mortgage and pockets additional money. For example: The seller owes $50,000 on a home and pays 5% in interest to his bank. He sells the home for $100,000 with a 7% interest rate. Each month the buyer sends a mortgage payment to the seller. The seller then pays his bank the amount owed and keeps the excess.
How to Qualify for Seller Financing
There are no universal requirements mandated for seller financing. Instead, each seller sets his own standards. Most people offer seller financing with the knowledge that it will appeal to buyers with poor credit or other financial problems. However, sellers may still want some type of assurance that they will be paid back. They may ask for credit reports, income documentation, or other information. Since these deals tend to be worked out face-to-face, buyers often have the chance to explain their situation and negotiate the loan terms.
Benefits of Seller Financing
Seller financing allows homebuyers to take out a mortgage without having to meet strict underwriting guidelines. Although the interest rates may be higher than those offered through traditional lenders, buyers save on fees such as closing costs and primary mortgage insurance (PMI). With seller financing, it may also be possible to arrange unusual deals such as cash back allowances. Many financial issues that hinder traditional loan applications can be worked out between buyers and sellers – almost everything is negotiable.
Drawbacks of Seller Financing
On the downside, seller financed properties tend to sell for more than comparable properties. Buyers pay extra in principle and interest for the convenience of avoiding banks. If buyers do not request an appraisal or home inspection, they may find themselves paying too much for a property with problems. If the seller is unaware of title issues (other people who hold liens on the home), the buyer may not be able to hold a clear title even after he pays off the mortgage. In the case of wraparound mortgages, buyers must trust the seller to make monthly payments to the primary lender. If the seller doesn’t follow through, the buyer may lose his home through foreclosure.
How to Find a Seller Financed Deal
Finding seller financed properties can be difficult. A real estate agent may be able to help you find homes with seller financing. However, many of these properties are being offered for-sale-by-owner and will not show up in MLS listings. Your best bet is to search in your desired neighborhood and through websites such as craigslist.com. In a buyer’s market, desperate sellers may be more willing to offer seller financing. Even if a home’s listing doesn’t mention financing options, it can’t hurt to ask the owner.