Seller financing, also known as owner financing, is a transaction in which an individual who owns a piece of real estate property outright, provides a loan to a party looking to purchase the property. There may or may not be a down payment required, and installment payments are typically made on the loan.
In traditional mortgage lending, the buyer and seller agree on a price for the real estate property, and the buyer secures a traditional mortgage for the purchase price less any down payment. At closing, after a lengthy underwriting process, the bank advances the full purchase price to the seller, who walks away with cash in hand, while the buyer makes installment payments covering principal and interest to the bank over a course of time.
In seller financing, there is no bank involved. The seller sets the terms of the loan including down payment and interest rate, and takes over the traditional role of the bank, collecting monthly payments from the buyer.
Why Would a Seller Offer Financing?
As the lending industry has slowly recovered from the housing crisis that began in 2007, qualification requirements for conventional mortgages have become much more stringent. As banks continue to tighten their lending guidelines, a sizable pool of deserving prospective homebuyers and available properties have been created, that can be effectively serviced through this alternative mortgage financing opportunity.
Seller financing offers a seller the opportunity to sell their home faster by exposing it to a larger pool of prospective buyers who cannot qualify for a traditional bank loan, and are otherwise deserving buyers with redeeming qualities.
From the seller’s perspective, providing a loan to the buyer is akin to an investment. The seller expects to recoup their original investment, and earn additional returns through any down payment they may require, as well as through many years of monthly principal and interest payments they’ll receive.
Sellers utilizing seller financing may realize a tax advantage because rather than paying taxes on a lump sum payment received through the traditional sale of a home, the tax liability is spread out over many years because they’re earning money monthly.
A seller-financed transaction typically takes less time as well, because the traditional underwriting process performed by a bank is bypassed.
A seller financed investment is also protected because the physical property serves as collateral for the loan. The seller still performs due diligence, just as a bank would, to ensure the buyer will be able to make payments on the loan. They look at things like the buyer’s credit, income, and payment history to assess the investment risk. In the event the buyer defaults on payments, the seller has the option to foreclose on the property to satisfy the debt.
Seller financing offers additional flexibility in that a seller who decides they no longer want to collect regular monthly payments, has the option of selling the note attached to the borrower’s mortgage, to investors who specialize in note buying, for a partial or lump sum cash payment.
Why Would a Buyer Choose Seller Financing?
For a buyer, seller financing is a great option, especially if they know they will have trouble obtaining a traditional loan from the bank. They may be self-employed which can create difficulty in proving income, or they may have experienced financial issues in the past that are still negatively impacting their credit. The buyer may also be able to work out better terms with the seller, than a bank might provide.
In addition, buyers won’t have to pay additional costly expenses such as loan origination fees, discount points, or mortgage insurance premiums that typically add up to thousands of dollars in extra costs when dealing with a traditional lender.
Things to Consider with Seller Financing
Like any investment, seller financing involves a level of risk that should be appropriately mitigated before finalizing any agreements. It was lack of appropriate due diligence that contributed in part to the 2007 housing crisis after all, so it makes sense for an individual or real estate investor to carefully consider the viability of a borrower before providing seller financing.
In addition to considering a potential buyer’s credit history, income, and payment history, a seller should also obtain an accurate valuation of the property and understand what potential exists for appreciation or depreciation in value.
Additionally, it’s wise to give some consideration to the loan-to-value ratio (LTV). Generally, traditional lenders set limits on how much of the total value of a property they’re willing to lend as a means to limit their risk. They base this number on things like the borrower’s credit score and the type of property being purchased (stick-built vs. manufactured for example). The lower a borrower’s credit score, the less a bank may be willing to lend.
In a seller financed transaction, the seller may also want to consider these factors when determining an appropriate down payment and interest rate from the borrower. A borrower who is willing to offer a higher down payment is less likely to walk away from a loan. An appropriate down payment also provides the seller with enough money on hand to cover costs associated with the unlikely event a foreclosure is necessary.
A buyer who is considering seller financing will also want to adequately protect their interests in the transaction by conducting their own due diligence on the property they’re considering. They should perform a title search to ensure the home is fully owned by the seller and there are no additional liens on the property. They may want to order a home inspection, and they should have a strong understanding of the surrounding market to ensure the home is priced appropriately.
Both parties may want to utilize an attorney to ensure all documents are legal and binding.
Alvernia Capital Management and Seller Financing
Alvernia Capital Management’s unique position as a real estate investor allows us to provide seller financing as part of our business offerings.
We are able to do this through our inventory of homes originally acquired as non-performing notes, that have been fully rehabbed and made available for purchase to deserving homebuyers who may be limited in their ability to acquire traditional financing.
Seller financing supports our mission of stabilizing affordable neighborhoods across the U.S., as we match buyers to homes, drive equity appreciation in improving neighborhoods, and strengthen communities throughout the U.S.
If you’d like more information about Alvernia’s role in seller financing, fill out the form here, and we’ll get in touch with you for a free consultation.