Seller Financing

When the Seller Becomes the Bank

Seller Financing occurs when there is no other way for the homeowner to sell their property except if they decide to offer the potential purchaser financing of their own.

If you've ever picked up the real estate section or looked on a For Sale By Owner site and seen the term "Owner Will Carry" or "Carry Back Paper", these terms refer to the willingness on the seller's part to be the lender for some or all of the purchase price.

What kind of financing and how much is always negotiable. The most common seller financing offered to buyers are when the purchaser has an 80% conventional mortgage from a lender, but no down payment money of their own. If the seller is anxious enough and really wants to sell the home, then they will agree to loan a portion of their equity back to the buyer. In this case, it could be the full 20%, or some other percentage all parties agree to.

The first thing you need to consider when deciding whether or not to use seller financing is can you afford the payments for both loans, in addition to all other expenses, such that the property still cash flows.

In this scenario, because the seller is going to be the 2nd lender so to speak, they are assuming more risk, because if the house were to get foreclosed upon, the 1st lender gets paid back before they do. So to compensate them for that, they normally will get a higher interest rate, and some times a shorter loan term. So you must watch the payments carefully or you even though you scored a property with no money down, you now have a negative cash flow every month because your payments are so high!

If you do arrange a shorter term to payoff the seller, this is called a balloon payment. For example, the seller loans you $20,000 at 10% for seven years with interest only payments due monthly, and at the end of the seven years you must pay back the orignal principal of $20,000. If you don't, they can take the house back. Obviously, over the course of seven years you could have accumulated a lot of equity in the property, so you wouldn't want that to happen. So be careful when agreeing to these terms that you:

a. Have enough equity in the primary property to pay the seller back at the end of the term by refinancing and pulling the $20,000 out - OR -

b. Have equity in another property that you can pull out - OR -

c. Have a source to get money from if a and b fail - OR -

d. Have a clause written into the original note stating that if at the end of seven years you do not have the money, you have another year to get the money and you will continue your interest only payments.

In other words, leave yourself some wiggle room in case the market doesn't appreciate like you had hoped.

Other Seller Financing scenarios occur when the owner offers you 100% financing. This is much more common with sellers who own properties outright, but cannot sell the property. There may be more money in it for them to give you financing than trying to rent the home. And they won't have to be landlords.

For example, I knew a couple who inherited their mother's home, and it was completely paid off. They tried for almost a year in a declining market to sell it, but just couldn't stomach settling for the low price the market was offering. Enter a friend of their son's who couldn't get a loan to buy a house because of his poor credit and lack of a down payment. Since they knew him, they felt comfortable overlooking his flaws. They ended up 100% financing a mortgage to him to the tune of $2600 in monthly cash flow, in a market where they could only have rented it for $1600. Plus, they received a purchase price of $50,000 more than the market was bearing because they were taking a risk on him. Do you think that was a happy day for them?

One last type of seller financing that may be available to you is what's called buying the house "subject to" the seller's existing mortgage. Basically, you agree to take over the payments of the seller's existing loan(s). This is usually done when a seller owes close to fair market value on the home, so selling it on the open market may not make sense. They can avoid making payments during the time the home would have been on the market, which in a slow or buyer's market could be a while, and also avoid the realtor commissions. The bonus for the investor is not having to get new financing, avoiding most closing costs, and only having to give the seller a very small amount of money to walk away.

As with all creative types of financing, this one has risks too. There is a chance the lender could find out you've technically assumed the mortgage (even though you usually don't report it) and call the note due. But alas, most mortgage companies don't have the staff to monitor who is writing the monthly mortgage payment check, so this kind of thing generally goes undiscovered. Still, it is something to be aware of.

Bottom line with Seller Financing, as with all other techniques in this section of the website, is to be creative, and present a win-win to both parties. Investments that might not otherwise have been possible can become a reality with a cooperative seller!