How Does Seller Financing Create Opportunities?
Seller financing, also known as owner financing, is a transaction in which a real estate owner provides a loan to the purchase of a property.
A down payment may or may not be required. Typically, installment payments are made on the loan.
In traditional mortgage lending, the buyer and seller agree on a price for the property. Then the buyer secures a traditional mortgage to cover the purchase price, minus 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. The buyer pays the bank in installments covering principal and interest for the loan term.
With seller financing, no bank is involved. The seller sets the terms of a loan, including the down payment and interest rate. Then the seller takes over the traditional role of a bank, collecting monthly payments from a buyer.
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How Does Owner Financing Create Opportunities for Sellers?
Qualification requirements for conventional mortgages became much more stringent after the housing crisis that started in 2007.
As banks tightened lending guideline, sizable pools of prospective homebuyers and available properties were created. Both sellers’ and buyers’ needs are met through alternative financing such as seller financing.
Seller financing helps sellers sell homes faster. How? By exposing the property to a larger pool of prospective buyers who cannot qualify for traditional bank loans, but otherwise are deserving buyers.
From a seller’s perspective, providing a loan to the buyer is akin to an investment. The seller expects to recoup the original investment and more. Sellers earn additional returns through a down payment plus many years of monthly principal and interest payments.
Sellers who use seller financing may gain a tax advantage. How? Rather than pay taxes on a lump sum received in one year, a seller’s tax liability is spread out over many years, since money is earned monthly.
Seller-financed transactions may take less time because they bypass banks’ traditional underwriting process.
A seller-financed investment is protected, since the physical property is collateral for the loan. Sellers still must perform due diligence, just as a bank would, to ensure that buyers can make loan payments.
Sellers look at the buyer’s credit, income and payment history to assess investment risk. In the event a buyer defaults on payments, the seller can foreclose on the property to satisfy the debt.
Seller financing offers additional flexibility. For example, if you no longer want to collect monthly payments, you can sell a partial or whole note to investors for cash.
How Does Seller Financing Create Opportunities for Buyers?
For buyers, seller financing is a great option, especially when they can’t get a traditional bank loan. Buyers may be self-employed, which creates difficulty in proving income. Buyers may have experienced past issues that hurt their credit. Or they may be able to get better terms from a seller than a bank.
With seller financing, buyers don’t pay costly loan origination fees, discount points or mortgage insurance premiums. With traditional lenders, all these expenses add up to thousands of dollars in extra costs.
What to Consider with Owner Financing
Like any investment, seller financing involves risks you need to mitigate before finalizing agreements. After all, a lack of appropriate due diligence contributed to the 2007 housing crisis.
Before providing seller financing, carefully consider a potential borrower’s viability. Look at the borrower’s credit history and income and payment history. Also get an accurate 3rd party valuation of the property, to understand its potential for appreciation or depreciation.
It’s wise to consider 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, in order to limit their risk.
Lenders base this limit on a 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 will lend.
Before settling on a down payment amount and interest rate, sellers should consider these factors:
- A borrower who is willing to offer a higher down payment is less likely to walk away from a loan.
- An appropriate down payment provides the seller with enough money on hand to cover costs, just in case a foreclosure becomes necessary.
To adequately protect the buyer’s interests, buyers should conduct their own due diligence on a property:
- Perform a title search to ensure the home is fully owned by the seller.
- Make sure there are no additional liens on the property.
- Order a home inspection.
- Get to know the surrounding neighborhoods to ensure the price is right.
Both parties should use an attorney to ensure that all documents are legal and binding.
Alvernia Capital Management and Seller Financing
As real estate investors, we provide seller financing.
We hold an inventory of homes originally acquired as non-performing notes. These homes have been fully rehabbed. They’re available for purchase by deserving homebuyers who can’t get traditional financing.
Seller financing supports our mission of stabilizing affordable U.S. neighborhoods. We match buyers to homes, drive equity appreciation in improving neighborhoods and rebuild communities.
For more information on seller financing, schedule a free consultation here.