How Does Seller Financing Work In Real Estate?

There are many people who are recovering from the real estate bubble that could benefit from an understanding of seller financing for residential real estate.

There are sellers who do not have buyers for their homes, and there are buyers who have not yet recovered their credit and could benefit from the use of unconventional financing techniques.

Whether you are a buyer, a seller, or even a real estate professional, there are some import considerations you should review before you commit to a real estate transaction that includes seller financing.

How Does Seller Financing Work?

This is probably one of the most-asked questions that I get when discussing creative financing techniques. Surprisingly, the answer is simple.

Seller financing is simply the act of the seller taking a part of the sale as a note, instead of receiving cash. The seller then acts no differently than any other lender, by getting a note and mortgage drafted to protect the seller's remaining interest in the property (a lien holder's interest).

Here are two common scenarios where owner financing helps create a "deal" when one is not available under conventional processes:

1. Owner as the primary lien holder - Let's say a buyer did a short sale two years ago and has saved enough money for a decent down payment. Currently, the buyer might not be able to get conventional financing due to credit issues or time issues (since the date of the short sale), so the buyer asks the seller to "act as the bank." The buyer makes a down payment (say 20%), and the seller takes a purchase money note and mortgage for the difference (80% in this case).
2. Owner as the secondary lien holder - In this case, perhaps the buyer is able to convince a lender to bring in the majority of the cash required to buy a home, but still needs help from the seller to get to the full contract amount. For example, maybe a lender will do a loan for 70% of the purchase price, and the buyer has enough for a 20% down payment. The buyer then asks the seller to finance a "second mortgage" for 10% of the purchase price, meaning the seller will be in second position behind the first mortgage holder.

Wouldn't The Seller Prefer Cash?

Yes. Most would. But what about the sellers that are not getting cash offers? Perhaps they would rather hold some level of seller financing than to not sell their home at all.

In the Tallahassee market, 274 homes sold in September, but 270 left the market without selling. I suspect some of those 270 would have considered a purchase money note and mortgage from a buyer with a very (otherwise) strong offer.

The fact is that sellers prefer to get a bag of cash at closing, but (as Mick Jagger would say) you can't always get what you want. If there are no well qualified buyers who want your home, you might have to extend your reach to the next level of buyer ... one that needs your help with the financing.

Are There Other Benefits For Sellers Who Hold Financing?

Absolutely. Let's say you are at or near retirement age and you own your home free and clear. If you sold it for cash, what would you do with the proceeds? Where would you invest the money and what kind of return would you get on your investment?

Well, if you hold owner financing, you can demand a specific rate of return, right? Why not agree to finance an amount of the home that you feel is a safe bet (like 65% of the purchase price, as the primary lien holder).

So long as you vet your buyer, you likely will not lose on the investment and you can get a better rate of return in a relatively safe investment.

Tips On Staying Safe When Holding Seller Financing

Any time you invest, there is risk. The buyer of the home could stop making payments and could trash the property. This is why you must vet the buyer and it is why you should ensure that the buyer has significant "skin in the game."

If you hold most or all of the home's value as a loan, it doesn't exactly put a fear of loss into the buyer. But if they have to come up or borrow from friends and family a third of the value, then you are likely safe from default.

So long as you monitor their payment behavior and respond rapidly to any type of default (meaning they are more than 30 days late on a payment), you will be able to protect your investment.

There are plenty of other tips that make sense based upon the myriad of situations that can arise. For this reason, you should only attempt to use seller financing when you have the assistance of an expert.

Many legal experts can guide you on the paperwork to use, but you want a real estate professional who has experience beyond conventional financing before putting such a large investment through the owner financing paces.

If you would like to know more about seller financing and how it can help you sell a home, just drop me a note and we will arrange a time to meet to evaluate your specific situation and needs.