Seller financing (also known as owner financing or a seller carry-back) is when the seller acts as a bank, extending credit for the purpose of making a profit. Usually, the seller has already paid off their mortgage and owns the house free and clear. This allows them to finance it however they would like.
Benefits
Since the seller is extending credit, they can ask for a higher overall price. The buyer can work more quickly if they don’t have to use a bank.
The seller gets to earn interest, which is a build-in way of investing their money. Use our seller finance calculator to get an idea of how much this might be! The buyer can make sure their payment is affordable.
The seller’s income is passive and spread out over time, which has tax benefits. The buyer gets to use leverage.
The transaction can go a lot faster and have lower closing costs because no banks are involved.
The parties are able to negotiate all terms to mutual benefit, including price, interest rate, down payment, and repayment schedule (e.g. how long the financing is for and when any balloon payments are due).
Drawback
The drawback is the same as the one a bank would have – needing to foreclose on a buyer who stops making payments. Because of this, it is important to ensure that the transaction is based on sound financials and that the buyer is responsible. In any case, foreclosing on the house would return the house to the seller.
How it Works
The mechanics of a seller financing arrangement are quite straightforward. A promissory note is created containing the repayment terms, ownership is transferred, and a mortgage (or deed of trust) is recorded to secure the seller’s interest. The promissory note and mortgage are related, essentially giving the seller the right to foreclose on the house in the event the buyer does not fulfill the requirements of the note.
Advanced concepts
Balloon payment
A balloon payment is a lump sum due after a certain number of years. If the amortization is over a 30 year period (making the buyer’s monthly payments manageable), the seller need not wait that long to get all of their money. A balloon due at 5 or 7 years would require the remainder of the loan to be paid at that point. Since market conditions are not always favorable for a buyer to refinance and pay the seller the balloon, a balloon extension or rollover can extend the period if the property doesn’t appraise for its original purchase price.
Graduated Payments
An alternative to a balloon payment is graduated payments. These are simply an annual increase in the monthly payments. If the monthly payments the first year are $1500, the second year they may be $1600, and so on.
Multiple Notes
Instead of one note, multiple notes can be created that are secured by the same mortgage. This allows the seller to sell one of the notes (yes, notes are sellable, even if at a discount) if they need to raise cash quickly, or it allows the splitting of notes between different people. Alternatively, it may be possible to sell a portion of a single note.
Other Ways to Transfer
An alternate way to transfer ownership is to use a contract for deed (or installment sale or land contract). In this arrangement, the buyer does not receive the deed until they pay off the note in full. Another way is to use a lease-option, which involves the buyer leasing the property with an option to buy it for a set price at a later point in time.
Contract Provisions
Various contract provisions are possible, and the following are just a few examples. Prepayment penalties or discounts can be included depending on whether prepayment is desirable. A first right of refusal provision can give the buyer the first right to buy the note if it is offered for sale. A payment reduction provision can reduce the monthly payment if the buyer reduces the principal owed by making extra payments. A substitution of collateral provision can allow the note to be collateralized by a different property if the buyer wants to sell the original property but keep paying on the note.
Conclusion
We love seller financing, and so do many sellers. If this kind of arrangement is something you may be interested in, let’s talk about it!