What does seller financing mean in real estate

What Does Seller Financing Mean In Real Estate?

June 28, 2022

Produced by:
Carmel Woodman

With over 8 years of expertise, Carmel brings a wealth of knowledge as the former Content Manager at a prominent online real estate platform. As a seasoned ghostwriter, she has crafted multiple in-depth Property Guides, exploring topics such as real estate acquisition and financing. Her portfolio boasts 200+ articles covering diverse real estate subjects, ranging from blockchain to market trends and investment strategies.

A quick summary

When times are tough, home buyers get creative. Particularly when it comes to financing. There are a variety of creative financing options for home buyers, and one of these is seller financing in real estate. Why go through a bank when you can get financing from the seller themselves? 

Key Topics

When home buyers are in a pinch and traditional financial institutions are implementing tight lending restrictions, they often resort to alternative methods to get funds for a property. This is called creative financing and one such method under this umbrella is seller financing. Seller financing essentially describes a real estate transaction where a property seller also serves as the lender in some way, for a home buyer. Let’s take a closer look at how this creative financing option works, as we answer the question, what does seller financing mean in real estate?

house-sold

What is seller financing?

Seller financing is a financial solution for home buyers whereby the current homeowner (the seller) provides partial or full funding for the house. This allows the buyer to pay the seller instalments every month, instead of having to take a traditional mortgage from a bank or other financial institution. Which means that the buyer can bypass all the red tape of the traditional lenders and use creative financing to make their property goals a reality.            

A purchase-money mortgage is another type of seller financing where the seller offers the buyer a mortgage instead and handles the process themselves. This is also called owner financing. This cuts out the middleman and allows the seller to be in control of the loan, instead of a lender.

How does seller financing work?

Before using seller financing, buyers should get to know the ins and outs of this financial option.

Seller acts as the lender

Seller financing means that the seller acts as the lender and extends a line of credit to the buyer for the purchase of their home. The buyer and the seller enter into an agreement for the buyer to repay the seller over a specified time period. This agreement is called a promissory note, which outlines the terms of the loan, ie: the interest rate and how long the loan is for. A mortgage is recorded with the local county.

Shorter loan period

These loans are often over a shorter time period than a traditional mortgage, with larger payments being required after a few years, because sellers simply don’t have the time to wait for the loan to be paid over a 30-year period.

Mortgage variables

Seller financing is usually done by sellers who don’t owe anything more on their home, or if the mortgage can be paid off with the buyer’s down payment. However, it is still possible if the seller still owes money on their mortgage. This will require the lender to approve the transaction ahead of time, but this isn’t always guaranteed.

money

The different types of seller financing

 

There are various types of seller financing to suit a variety of property purchase needs. Some of the most common ones are:

  • Lease option: The buyer will rent the property from the seller for a contracted period of time, in lieu of the buyer purchasing the property in the future. The seller will often require an upfront fee to secure this agreement, and some of the rental payments can be put towards to purchase of the home. Each agreement will have different terms.
  • Land contracts: This is a contract between a buyer and a seller, to purchase real estate by borrowing money from the seller and paying it off. This means that the buyer will share ownership using an “equitable title” until they have paid off the debt.
  • Assumable mortgage: This option allows the buyer to take over the seller’s existing mortgage. Typically, this is applicable for FHA and VA loans, along with ARM (Adjustable Mortgage Rate) loans, provided that the bank approves.
  • Holding mortgage: This is when the buyer pays the seller back in instalments for the property, under a holding mortgage agreement. Effectively, the seller is the lender in this scenario, and the seller will hold the property’s title until the buyer has paid back the loan in full.
  • Junior mortgage: These days, lenders often don’t want to finance more than 80% of the property’s value. Which is when sellers can step in and offer to cover the rest of the amount by using a junior or second mortgage for the balance.
  • All-inclusive Trust Deed: The seller will continue paying their mortgage in this option however, the buyer will be paying the home off to the seller in monthly instalments, which the seller then uses to pay off their existing mortgage. Any funds that are paid over and above the mortgage amount, the seller will keep.

Advantages of seller financing

For buyers:

  • Allows people who don’t qualify for a mortgage to own a home
  • Useful option for buyers with a lower income
  • Loan terms and down payments are often more negotiable with a seller than a bank
  • You can use the time to get your credit sorted out before you apply for a mortgage
  • You’ll pay less expenses than you would usually on things like closing costs

For sellers:

  • Save on closing costs
  • Save on capital gains tax in the long term
  • Save on property tax, homeowners insurance and maintenance costs
  • You can sell your property as-is
  • You can sell your home fast and for the price that you choose
  • Buyer payments are a passive income stream
  • You can charge a higher interest rate and get more interest than you would if you had invested the money elsewhere
cottage

Disadvantages of seller financing

For buyers:

  • There aren’t many regulations for the protection of home buyers
  • Buyers are at risk of a foreclosure happening if the seller can’t make their debt payments
  • A higher interest rate is often charged, for the seller to mitigate their risks
  • There may a balloon payment required within the first few months or years

For sellers:

  • All the risk falls on the seller
  • If you have an existing mortgage, your lender will need to approve the transaction first
  • If the buyer doesn’t live up to their end of the agreement, the seller has to deal with the consequences of that and enter into eviction proceedings or foreclosure
  • You won’t receive a lump sum for the property, so the risk of the sale falling through is higher

Tips to reduce the risk for sellers

For sellers, this kind of financing can be a big responsibility and potentially get them into hot water if they aren’t aware of the possible pitfalls. Here are some useful tips for sellers to have the most successful and secure transaction.

  • Put it in writing: A loan application is one of the documents that a seller should require for the transaction, so that the relevant background checks can be done. Then, the loan terms should be stated in detail in an agreement signed by both the buyer and the seller. It’s a good idea to include a contingency in this, which is that the sale can only go ahead once the seller has approved the buyer’s financial situation.
  • Secure the loan: The loan should be secured by the property, which means that if the seller needs to foreclose, the buyer will default on the property.
  • Down payments are a must: It’s important for a seller to get a down payment of at least 10% from the buyer in this type of transaction, because it gives the seller an extra layer of security and makes sure that the buyer is less likely to cancel the transaction easily.

The bottom line: Is seller financing a good idea?

As with most decisions about real estate, it all comes down to you and your individual needs. Seller financing can be a good choice for those who cannot get a traditional mortgage, and for some sellers this can be a good option to earn interest on their money, which creates a win-win situation. However, there are advantages and disadvantages for both the buyer and the seller, so you’ll need to weigh these against your needs, to make your decision.

Follow New Silver