If you think lending standards have tightened over the past year, wait until you see what’s in store for next year’s borrowers.
“Starting next year, qualified mortgage rules, known as QM, will expose originators to higher legal liabilities on loans carrying risky features or when payments exceed 43 percent of the borrower’s pay,” according to Bloomberg’s Jodi Shenn.
So, while the demand for mortgage loans isn’t expected to soften, conventional money will become even more elusive to borrowers.
You may not be able to turn to government-backed loans, which make up about 85 percent of new mortgages, either. “Policy makers are seeking to reduce their role,” according to Shenn.
For these reasons, seller financing may be a good option, for both buyers and sellers.
What is Seller Financing?
When a homeowner lends money to a buyer to purchase her home, she is engaging in seller financing. It differs from a bank loan in that the seller doesn’t provide cash to the buyer, but instead extends credit. Seller-financed loans are typically short-term and may carry a balloon payment. They are ideal for the buyer who has met challenges qualifying for a bank loan or meeting traditional credit score requirements.
The homeowner who owns his home free and clear is in the best position to offer financing. Those who still carry a mortgage typically need their existing lender’s permission to offer financing.
The challenge for the buyer seeking seller financing is finding a seller willing to help him out. Most sellers are reluctant to finance – less than 10 percent do – mainly because of the risk that the buyer will stop making loan payments. It is possible, however, to reduce the risk of default. Then there are the legal and logistical hurdles to overcome. Combined, these challenges convince most sellers that financing the buyer is too much work.
Benefits for Sellers
The biggest benefit for homeowners is the sizable return on investment they realize with seller financing. Borrowers who typically seek seller financing are considered a higher risk than others. Because of this, sellers commonly charge 8 or 9 percent interest on the credit extended, according to Michele Lerner at BankRate.com.
Offering financing is also beneficial in a buyer’s market, with lots of other homes on the market. It opens your home to a larger pool of buyers and may help sell the home quicker.
Benefits for Buyers
Seller financing can be a bonanza for buyers with less-than-perfect credit who can’t obtain financing from a traditional lender. Down payment requirements are typically lower as well.
The terms of the loan are negotiable, so you may be able to get a better rate than what banks offer. Depending on how the loan is structured, you may also get the tax benefits of homeownership.
Reducing the Risks
Experts recommend taking several precautions to reduce the risks inherent in seller financing:
- Require a loan application and verify all the information provided by the buyer. Run a credit check, verify employment and salary details, and call references.
- Secure the services of a real estate attorney to write up the sales contract, prepare the promissory note, and deal with any other required paperwork.
- Work with your tax professional on ways to maximize your return on the investment and avoid tax complications.
- Obtain a home appraisal to ensure the home is priced appropriately.
- Ask the buyer to sign a sales contract that specifies the rate and terms as negotiated.
- Secure the loan with the home so that the seller can foreclose if the buyer defaults.
- Ask for a down payment. Buyers are much more likely to stick around if they have some skin in the game.
- Record the mortgage or deed of trust.
Types of Seller Financing
Sellers can choose from a variety of financing options, and much of the choice will be based on the buyer’s financial situation. Here’s a quick look at a few of the more common types:
Assumable mortgage – This type of seller financing allows the buyer to take over the seller’s existing mortgage. Not all mortgages are assumable, but VA loans and some FHA and conventional mortgages are. You’ll need the lender’s approval with this option.
Land contract – With a land contract, title isn’t conveyed to the buyer, but she gets what is known as “equitable title,” a shared ownership until the loan is paid in full.
Lease option – This method allows the buyer to lease the home for a specified amount of time. The rent is typically higher than market rents and there is an upfront fee, akin to a security deposit, which the buyer will forfeit should he decide not to purchase the home at the end of the lease. The terms of a lease option are negotiable. These generally include the length of lease, what portion of the rent is credited toward the purchase, and the purchase price. For this reason, there is no standard lease option.
The all-inclusive mortgage and junior mortgage are two other popular methods of providing seller financing. Ask your real estate attorney for details on these options.
Since determining an appropriate purchase price and interest rate may be challenging for the homeowner, don’t hesitate to seek the counsel and services of professionals. A real estate attorney can help with most of the process and then, after the sale, consider hiring a loan servicing company to handle payment collections and take care of other paperwork.
Read More: realestate.com