• calendar_month August 3, 2023

Seller financing is when you get a mortgage to buy a home from the home’s seller instead of a bank. Let’s review when this approach is suitable, as well as pros and cons for buyers and sellers.

When to Use Seller Financing

Seller financing is rare overall, especially in a hot real estate market where sellers have their pick of buyers.

Seller financing becomes more common in tough real estate markets when bank lending tightens up and/or buyers have been hit by hard economic times that make it difficult to qualify for a traditional bank loan.

To do seller financing, sellers must own their home outright, or have enough equity in their home for the sale transaction to pay off their existing loan.

For example, if someone was selling their home for $300,000 and only owed $30,000 on their existing loan, they could require a 10-percent down payment from a buyer to do seller financing. That 10-percent down payment would pay off their $30,000 loan, and they could do seller financing for the remaining $270,000.

If, on the other hand, they owed $150,000 on their existing loan, the buyer’s 10-percent down payment would only pay their loan down to $120,000, so they’d need their lender’s permission to offer seller financing for as long as it took them to pay off the $120,000 — and it’s extremely rare for a traditional lender to grant this permission.

As for when buyers should use seller financing, the most common reason is that a buyer might not qualify for a traditional bank loan.

This could be because of challenges in a buyer’s credit, income or asset profile. Or it could be because the property needs repairs that a traditional lender requires to be completed before they fund the loan.

In both cases, seller financing is a way to buy a home without being subject to these traditional lender requirements.

Pros of Seller Financing

Key benefits for buyers using seller financing include:

• Less stringent loan approvals. Even the most sophisticated sellers are unlikely to subject a borrower to the same rigorous federally-required loan approval procedures and documentation banks use.
• No mortgage insurance for low-down-payment deals. Most bank loans with less than 20 percent down require mortgage insurance ranging from about 0.45 percent to 1.05 percent of a loan amount. On the $270,000 loan example above, this translates to $101 to $236 per month in extra financing costs.

Key benefits for sellers using seller financing include:

• Control over timing of closing. In bank-financed deals, sellers are subject to timing and viability of bank financing coming through. With seller financing, they can close faster because they’re the lender.
• Good source of income. Seller financing creates a monthly income stream the seller can rely on in lieu of a lump sum payment at closing. This income includes a rate of return (the interest rate they charge the buyer) on top of eventually getting their equity in the property back when the loan is paid off.

Key benefits for both buyers and sellers include:

• Lower closing costs. Seller financing avoids bank fees, which makes the transaction cheaper for all parties.
• Property can close “as is”. As noted above, seller financing means a seller won’t be subject to a bank requiring certain repairs be made to the property before the loan can close.
• Reliable way to sell to tenants. If the buyer is a tenant who wants to buy the home, the buyer gets the home they’re already living in, and the seller already knows about payment history and creditworthiness of the buyer.

Cons of Seller Financing

Key drawbacks for buyers using seller financing include:

• Buyer unknowingly can assume seller risk. If the seller has liens or other claims from creditors in title that the buyer doesn’t know about (or even the seller doesn’t know about), the buyer could inherit these obligations as the new owner.
• Less organized monthly payment processing. With seller financing, it’s harder to do auto payments, and also you might not receive monthly payment statements and loan balance updates reliably because a private lender won’t have a systematic billing process like a bank does.

Key drawbacks for sellers using seller financing include:

• Less cash on hand at closing. The seller is trading lump sum cash for monthly payments.
• Risky income stream. The seller will never truly know if a buyer will pay over time. A buyer could lose their job, die, etc. A seller is taking on the same risk a bank does.

Key drawbacks for both buyers and sellers include:

• Less defined legal process. When a bank approves a loan, federal regulations make it clear what they’re supposed to do and how they’re protected if they follow the regulations. When a seller approves a loan for a buyer, both parties are only protected by whatever language they handcraft themselves or with the help of attorneys.
• Long, complicated foreclosure process. If the buyer eventually can’t pay, both buyer and seller are in for a long, expensive foreclosure process.

Tips When Using Seller Financing

Don’t try to save money by not using real estate agents or lawyers. Buyers and sellers must have professional advice to protect their individual interests.

It’s easy for buyers and sellers to find a good real estate agent, who can often recommend a good attorney.

Buyers should also get formally pre-approved by a mortgage lender. This will help them know what they can afford so they don’t have to take their seller’s word for it. This will also help buyers understand their end game. Before buying, it’s critical for a buyer to know whether they qualify for bank financing, because seller financing terms typically require the loan be paid off within three to seven years.