Home Sellers - Can
You Finance The Sale Yourself?
What is seller financing?
How are the rates set for seller financing?
What is a
wrap-around loan?
What are
the benefits and risks of seller financing?
What is seller financing?
Seller financing is when a seller helps to finance a real estate
transaction by taking back a second note or even financing the
entire purchase (purchase-money
mortgage) if the seller owns the home free and clear.
Usually sellers do this when a buyer has difficulty qualifying for
a conventional loan or meeting the purchase price. Seller
financing differs from a traditional loan because the seller does
not give the buyer cash to complete the purchase, as does a
lender. Instead, it involves extending a credit against the
purchase price of the home while the buyer executes a
promissory
note and trust deed in the seller's favor. These special
circumstances must be acceptable to the lender who makes the first
mortgage on the property. The necessary paperwork is prepared by
the title or escrow company after the terms are worked out between
the buyer and seller. If you are a seller considering such an
arrangement, it is critical to thoroughly evaluate the
credit-worthiness of the buyer first. Fear of default makes many
sellers reluctant to take back a second. But seller financing can
bring a higher price plus complete the sale sooner in some
situations. Seller financing may also take the form of a
Land Contract,
lease-purchase (lease-option), or
equity sharing. See also
How are the rates set
for seller financing?
The interest rate on an
owner-carried loan is negotiable. Ask your
agent to check with a lender or mortgage broker to determine the
current rate on institutional first (or second) loans.
Seller financing typically costs less than conventional financing because
sellers don't charge loan fees (points). Interest rates on an
owner-carried loan will also be influenced by current
Treasury Bill and
certificate of deposit rates. Sellers usually aren't
willing to carry a loan for a lower return than they would earn if
their money was invested elsewhere.
What is a wrap-around loan?
The wrap-around loan
method of seller financing is best described by an example. Suppose
Mr. Sellers currently has a $70,000
mortgage on his home. Mr. Byers makes an offer to purchase the
home for $100,000. Mr. Byers says he can pay $5,000 down if Mr.
Sellers will finance the remaining $95,000.. Mr. Sellers sees
an opportunity to make some money. The interest rate on his current
loan is only 5.5%. The going current market interest rate is 7.5%.
He then offers to carry Mr. Byers' $95,000
mortgage for 8%. Because Mr. Byers' credit history isn't
what it should be, he jumps at the chance to avoid the hassle of
getting a conventional loan.
To protect both of them, they execute a legal "deed of trust" and
properly record it. (Note: this is
the second deed of trust recorded for this property.) Mr.
Byers' $95,000 mortgage "wraps around" Mr.
Sellers' $70,000 mortgage. Mr. Byers moves into the house, and makes
his 8% interest and
principal payment monthly
to Mr. Sellers on the second $95,000 mortgage. Mr. Sellers
continues to make his 5.5% monthly interest and
principal payment to
the original lender on the $70,000 mortgage and pockets the
difference as profit. Everybody's happy. Sound like a win -
win situation? Maybe. Although what Mr. Sellers and Mr. Buyer
have done is perfectly legal, it is not without risk. This
arrangement works as long as Mr. Sellers' original loan agreement
does not contain a "due-on-sale"
clause. Because if there is a due-on-sale or a due-on-transfer
provision the
remaining balance of the underlying loan might be called "due"
when the first lender becomes aware that the property has "sold" and
title has transferred. The
original lender might then invoke their first "deed of trust" and
sell the property for the amount of principal that has not yet been
repaid. Mr. Sellers loses his $95,000 mortgage and Mr. Buyer loses
the house. At the very least, the original lender will
increase the interest-rate and
probably charge a hefty assumption
penalty to Mr. Byers, and possibly a pre-payment penalty
to Mr. Sellers. In either case the situation is now - "lose-lose."
The "wrap-around loan"
can be a useful tool to both buyer and seller if it's applied
correctly and under the right circumstances. But, never, never enter
into it without the help of a competent title attorney to advise you
of the inherent risks and write a contract that protects both your
interests, as well as the seller's.
What are the benefits
and risks of seller financing?
Seller financing offers tax breaks for sellers and alternative
financing for buyers who can't qualify for conventional loans. If
you are a seller, the risks you face are the same as those facing
any lender:
You should run a full credit check on the
borrower, require hazard insurance on the property and include a
due-on-sale clause. There also are financing, disclosure and
repayment-term requirements that need to be met. It is wise to
consult a lawyer when putting together this kind of transaction.
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