The practice of seller financing goes by many names, including purchase-money mortgages and owner financing. But in its simplest terms, it describes a form of real estate lending transaction in which a property owner also serves as a mortgage lender. This unique situation in the home selling process eliminates the need for a financial institution to handle financing agreements and negotiations.
Seller financing is championed by some property owners and real estate pros as a way to help home buyers qualify for additional mortgage opportunities, reduce the amount of red tape associated with home sales and improve profit margins on lending. But while seller financing effectively sees a seller provide a buyer with direct financing, it also comes with pros and cons attached, as with any nontraditional mortgage option. Noting this, it’s important to do your research and consult with a qualified professional before entering into a seller financing agreement.
What Is Seller Financing?
Seller financing is a type of real estate agreement that allows the buyer to pay the seller in installments rather than using a traditional mortgage from a bank, credit union or other financial institution. A seller financing agreement functions along similar lines as a mortgage loan, except that it cuts out the middleman and allows the home seller to own and oversee the debt instead of a traditional lender.
If you choose to opt for a purchase-money mortgage (a mortgage that is issued to a home buyer directly by a property seller), then the seller will provide financing and handle the mortgage process, during which you will enter into a mortgage with the seller instead of a corporate lender. Also sometimes referred to as owner financing or purchase-money mortgages, seller financing’s advantages include no minimum down payment, homeownership access for those with poor credit and fewer regulations. But these same upsides can quickly become disadvantages as well.
Common Types Of Seller Financing Agreements
Certain home buyers may find these options (which may provide more opportunities to finance a home purchase and may even come without a credit check attached) attractive, especially low-income or first-time home buyers. Be advised, though: Some seller financing offers may function more like rental agreements than traditional mortgages, and offer unfavorable loan terms that offset any initial benefits to be had. As with any form of mortgage agreement and legally binding real estate contract, it’s important to do your research and consult with a qualified professional upfront.
Let’s look at the most common types of seller financing arrangements:
Land contracts: A land contract is an agreement to purchase a piece of real estate that involves buyers borrowing money from the real estate owner until the purchase price is paid in full, rather than from a bank, credit union or financial institution. Land contracts typically work in a unique fashion where a balloon payment, or lump sum, comes at the end of the repayment period after the repayment plan is negotiated between the two parties.
Assumable mortgage: An assumable mortgage is a type of home financing in which buyers are given the opportunity to purchase a home by assuming responsibility for and taking over the seller’s current mortgage (especially if it’s charged at a lower interest rate).
Lease purchase: Also known as a rent-to-own contract, a lease purchase agreement speaks to a form of agreement under which renters pay sellers an option fee at an agreed-upon purchase price that gives the renter the exclusive lease option to purchase the property at a later date.
Holding mortgage: Under a holding mortgage agreement, a homeowner agrees to serve as a lender for the home buyer, and provides a loan for the purchase, which the buyer repays by making monthly payments to the seller. The seller continues to hold the property’s title until full loan repayment has been made by the buyer.
Seller Financing Advantages For Sellers
Seller financing may prove a good option for those wishing to lend money. Select upsides associated with providing it include:
Ability to save on closing costs
Can produce significant capital gains tax savings over time
Faster time to sale, and the ability to sell your property as-is without the need for repairs
Released from property tax, homeowners insurance, and various maintenance expenses
Option to sell the promissory note to an investor
Seller Financing Advantages For Buyers
Buyers may also enjoy several benefits should they elect to buy an owner-financed home, such as:
Greater access to financing opportunities, especially for low-income buyers
Lower expenses associated with closing costs
More flexible agreement terms
Potential for no PMI premiums
More accessible for those with poor credit
Disadvantages Of Seller Financing
As alluded to above, seller financing is not without its potential drawbacks as well. Items you may wish to keep in mind as you consider whether to pursue this form of real estate financing option are as follows:
Fewer regulations that protect home buyers
Buyers are still vulnerable to foreclosure if the seller doesn’t make mortgage payments to senior financing
No home inspection/PMI may result in the buyer paying too much for the property
Higher interest rates and a bigger down payment are required
Seller faces risks if the borrower defaults on payment
Seller financing presents upsides and downsides to home buyers and sellers alike. With these agreements, purchasers with lower credit scores or incomes may be able to obtain loans that they could not have been approved for otherwise.
At the same time, the interest rate that a seller may charge can often exceed that charged by a traditional mortgage lender. So, while seller financing can open up more possibilities to aspiring home buyers when it comes to real estate transactions (and potentially provide home sellers with added investment opportunities and tax savings), it won’t make sense to utilize it in every case.
To learn more about seller financing and whether it’s ideal for you, research and consult with a qualified professional such as a real estate attorney before entering into an agreement.
Review the terms and conditions of any owner financing contract, too – they may vary greatly between agreements as well. Crunch the numbers to see if upfront savings on a property purchase made in this fashion may cost you more in the end.