DEC 5, 2022
As interest rate hikes show less signs of slowing down in a high inflation environment, homebuyers & sellers are having to get more and more creative when it comes to completing transactions. Although seller financing isn't a new idea, usually < 10% of residential transactions use this method in favor of more conventional routes of home purchase. In most cases, seller financing is a useful tool during high interest markets where buyers' purchasing power has taken a significant hit. This allows a seller to still sell their home in a reasonable time, and lets the buyer benefit from less strict qualifying & downpayment requirements.
In simple terms, seller financing (aka purchase-money mortgage) is when the homeowner becomes the "bank" to the homebuyer. Instead of giving a bundle of cash to the buyer, the seller gives the buyer credit (a loan) to buy the house — minus any downpayment the buyer puts upfront. Both parties will then sign a promissory note and record a mortgage with the relevant public authorities.
From the buyer's perspective, seller financing is very similar to signing any other mortgage. However, with seller financing, the buyer is typically dealing with less strict qualification and downpayment requirements. Once the mortgage is recorded, the buyer will payback the loan over time (usually with interest). Although the buyer benefits with easier qualification, the interest rate is typically higher for seller-financed homes. Additionally, seller-financed loans are typically setup in a way to have a large balloon payment due after a set period of time (usually 5 years).
For example, a seller may finance a buyer's home purchase with a loan that's amortized over 30 years but has a balloon payment due in 5 years. This is done because both the buyer & seller expect the buyer to refinance into a traditional mortgage prior to the balloon payment being due.
From the seller's perspective, seller-financing is a great way to attract more buyers to a property that is having a tough time being sold. Additionally, the seller has to ensure that her original mortgage holder is also ok with this type of transaction (assuming she still has a mortgage on her home). With that in mind, it's easier to understand why seller-financing is better suited for homes that are owned outright by the seller, or have a small mortgage remaining.
Assumable mortgage: In this scenario, the buyer assumes (takes over) the existing mortgage of the homeowner/seller. The homeowner might still net cash from the transaction depending on the final sale price of the home
Lease option: This is one of the more common types of seller financing because it allows the seller to lease the property out to the potential buyer for a specified term, and also agree to sell the property to the same buyer for an agreed upon price. The price is agreed on prior to the lease being signed, and the buyer will typically pay an upfront fee for this. Often times, the rental payments can also be credited towards the purchase price, depending on how the parties structured the deal.
Land contract: Although these aren't as common as the above two, a land contract gives the buyer equitable title (shared ownership) to the property but not the deed. Once the buyer has made all payments to the seller, then the deed is transferred to the buyer.
All-in mortgage: The seller carries the promissory note and mortgage for the entire balance of the home price, minus any downpayment the buyer has provided.
Junior mortgage: In situations where the buyer's bank is reluctant to provide the full offer price approval of the home, the seller can provide seller-financing for the remaining amount of the purchase price. The seller is thus carrying a "junior" mortgage on the house and can immediately get a large share of her proceeds from the home sale because the bank is providing the first mortgage amount towards the purchase. This comes with a trade-off for the seller, as in the worst case scenario where the buyer defaults — the seller will not be first in line to claim the repossessed home.
Note that this content is meant for informational purposes only and is not intended to be construed as financial, tax, legal, or insurance advice.
