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Marcus Wiley

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When it comes to financing residential real estate, most transactions follow a well-worn process. The seller finds a willing buyer with the required income, employment history and credit score to qualify for a mortgage, and a lending institution puts up the money to finance the deal.

But what if traditional financing is unavailable, and buyer and seller still want to proceed privately with the sale? Enter what's known as seller financing. As the term implies, the person who's selling the house finances the purchase, rather than the bank providing a mortgage to the buyer

The Advantages of Seller Financing
This alternative to traditional financing is a useful option at times or in places where mortgages are hard to get. In such tight conditions, seller financing allows buyers access to an alternative form of credit. Sellers, in turn, can tap a population of buyers who don't necessarily qualify for a traditional mortgage. And because the seller is financing the sale, the property may command a higher sale price.

A bank isn’t directly involved in a seller-financed sale; buyer and seller make the arrangements themselves. They draw up a promissory note setting out the interest rate, schedule of payments from buyer to seller, and the consequences should the buyer default on those obligations. Unlike a sale involving a mortgage, then, there is no transfer of the principal from buyer to seller, but merely an agreement on repaying that sum over time.

With only two main players involved, owner financing can be quicker and cheaper than selling a home in the customary way. When the seller finances the sale the deal closes faster, there is no waiting for the bank loan officer, underwriter and legal department to clear the file. 

Closing costs are indeed lower for a seller-financed sale. Without a bank participating, the transaction avoids the cost of mortgage or discount points, as well as origination fees and a host of other charges that lenders routinely level during the financing process. There's also greater flexibility, at least ostensibly, about the loan provisions, from the required down-payment to the interest rate to the term of the agreement.

The seller's financing typically runs only for a fairly short term, such as five years, with a balloon payment coming due at the end of that period. The theory­­­­—or the hope, at least—is that the buyer will eventually refinance that payment with a traditional lender, armed with improved credit-worthiness and having accumulated some equity in the home.

KEY POINTS
1.In residential real estate transactions, one option is seller financing: The person who's selling the house finances the purchase, rather than the bank providing a mortgage to the buyer.
2.Seller-financed transactions can be quicker and cheaper than conventional ones.
Buyers in the deal need to confirm the seller is indeed free to finance (no mortgage or the mortgage lender allows it) and should be prepared to make a down payment.
3.Seller financing typically runs for a shorter period than a conventional mortgage.
Both parties in the transaction should hire professionals to draw up the contract and promissory note.

What Buyers Need to Know
For all the potential pluses to seller financing, transactions that use it come with risks and realities for both parties. Here's what buyers should consider before they finalize a seller-financed deal.

Don't Expect Better Terms Than With a Mortgage
As the terms of a seller-financed deal are hammered out, flexibility frequently meets reality. The seller digests their financial needs and risks, including the possibility the buyer will default on the loan, with the prospect of a potentially expensive and messy eviction process.

The upshot can be sobering for the buyer. For example, it's possible you’ll secure a more favorable interest rate than banks are offering, but it's more likely you’ll pay more, perhaps several additional percentage points above the prevailing rate. And you'll probably have to provide a down payment that's comparable in size to those of a typical mortgage—that is, 20% or more of the property’s value.

You May Need to Sell Yourself to the Seller
It's smart to be transparent and straightforward about the reasons you didn’t qualify for a traditional mortgage. Some of that information may emerge anyway when the seller checks your credit history and other background data, including your employment, assets, financial claims, and references.

But make sure, too, that you point out any restrictions on your ability to borrow that may not surface during the seller's due diligence. Todd Huettner,3? a mortgage broker and the president of Denver-based Huettner Capital, points out that even a potential buyer who has good credit and a hefty down payment on hand may have recently started a new business, and so be unable to qualify for a loan for up to two years.

Be Prepared to Propose Seller Financing
Homeowners who offer seller financing often openly announce that fact, in the hope of attracting buyers who don’t qualify for mortgages. If you don’t see a mention of seller financing, though, it doesn’t hurt to ask about it, says Huettner.

When you do, he says, propose the option as explicitly as you can. Rather than asking if owner financing is an option, Huettner recommends that buyers present a specific proposal. "For example, 'My offer is full price with 20% down, seller financing for $350,000 at 6%, amortized over 30 years with a five-year balloon loan. If I don't refinance in two to three years, I will increase the rate to 7% in years four and five."

Confirm the Seller Is Free to Finance the Sale
Seller financing is simplest when the seller owns the property outright; a mortgage held on the property introduces extra complications. Paying for a title search on the property will confirm that it’s accurately described in the deed, and is free from a mortgage or tax liens.

According to Jason Burkholder4??, a broker, sales manager and real estate agent with Weichert, Realtors in Lancaster, Pa., "Most mortgages have a 'due on sale' clause that prohibits the seller from selling the home without paying off the mortgage. So if a seller does owner financing and the mortgage company finds out, it will consider the home 'sold' and demand immediate payment of the debt in full, which allows the lender to foreclose."

The Bottom Line
As unusual and unfamiliar it is to most people, seller financing can be a helpful option in challenging real-estate markets. However, the arrangement triggers some special risks for buyer and seller, and it's wise to engage professional help to mitigate those and allow the process to run smoothly.

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