Seller financing is a flexible option for buyer and seller
The basics of seller financing
- Seller financing removes the mortgage lender from a home sale.
- The buyer makes monthly payments plus interest directly to the seller.
- Seller financing is a more flexible option for buyers who can’t qualify for a conventional mortgage.
- Interest payments on the home can be a reliable investment for the home seller.
Mortgage lenders are by definition risk-averse. This can make it difficult for individuals with special circumstances to obtain a home loan. Not every home sale transaction requires a mortgage lender, however. For buyers who don’t qualify for a mortgage or sellers whose property condition doesn’t meet lender requirements, seller financing can be a useful strategy to complete a sale. There are several factors to watch out for, however, to ensure that both the buyer and seller are protected.
What is seller financing?
With seller financing, the home seller acts as the mortgage lender. The buyer makes monthly mortgage and interest payments directly to the seller. Seller financing can be all-inclusive or partial — all-inclusive meaning the seller is the only lender in the transaction, and partial meaning the seller is covering a portion of the loan with a mortgage lender in the first lien position.
Buyer pros and cons
Buyers should carefully research the pros and cons to seller financing.
Easier qualification. Seller financing is one method of purchasing a home where you don’t qualify for a mortgage based on credit score, down payment, income, self-employment or even the condition of the home. After the sale, buyers usually work to improve their credit and financials to refinance into a conventional mortgage within five years.
Payment flexibility. Seller financing is not subject to the myriad requirements of Fannie Mae, Freddie Mac or government-backed loans. This means that down payment amounts and repayment schedules can be arranged as both parties see fit. While most sellers will still require a down payment, it can be lower than a conventional mortgage would seek and often does not mandate the purchase of private mortgage insurance.
Faster, cheaper closing. With fewer parties involved, closing costs for a purchase with seller financing are lower, and the process can be completed faster than a typical purchase transaction.
No credit reporting. If there is no lending institution involved — for example in the case of all-inclusive seller financing — there will be no payment information reported to credit bureaus. This can be beneficial for a borrower seeking additional loans in the future, as their total debt on paper will not increase. It can be negative for someone who is trying to strengthen their credit with a record of steady repayment behavior, however.
High interest rates. As most buyers using seller financing do not qualify for a conventional mortgage and the lower interest rates that come with it, sellers often have the leverage to ask for higher interest rates. Particularly with buyer-initiated partial seller financing, the buyer can offer a seller an attractive, high interest rate in exchange for carrying part of the loan balance. While rare, in a stagnant housing market a seller may offer lower interest rates to quickly sell an unattractive property.
Seller pros and cons
There are some pro and cons for the seller to consider.
Potentially higher purchase price. Depending on the real estate market, seller financing can be a negotiating tool to use with the buyer. The seller could avoid having to make repairs to the house before the sale or use the flexibility of seller financing to entice wary buyers.
Return on investment. A mortgage is a product sold for profit. As such, when the seller assumes the role of the lender, they are making an investment with all but guaranteed returns in the form of interest. Buyers usually pay higher interest rates with seller financing than conventional mortgages, as well.
Tax benefits. Receiving payment for the home in installments can reduce the seller’s tax burden, which would be much higher if they received one large, lump-sum payment for the sale.
More work, but the loan can be sold. Seller financing is financially attractive for the seller, but requires additional administrative work that may not be the right choice for every lifestyle. Sellers can hire a loan servicing company to manage the paperwork and buyer payments, however. They can also make a partial note sale or sell the loan off completely. Just like a conventional mortgage can be sold to Fannie Mae or Freddie Mac, there are investors who purchase seller-financed mortgages.
Slow dispersal of funds. Many home sellers want to receive the full purchase price of their home up front, particularly if they are looking to purchase another home. Smaller monthly payments could be a boon to certain individuals, however, such as those moving into a senior living community.
Due on sale clause. Most mortgages have a due on sale clause that prohibits the homeowner from selling before they have repaid their mortgage in full. As such, seller financing is only a viable option for individuals who own their home in full.