18 May What You Should Know About Seller-Financed Mortgages
Seller-financed mortgages can be mutually beneficial to both home buyers and sellers. In seller-financed real estate deals, the seller agrees to loan the cost of the house to the prospective home owner. Therefore, the borrower will be paying mortgage payments to the seller and not to a bank. The seller then gets to earn interest on the loan, often at a higher interest rate than a financial institution would.
This type of real estate deal is especially common in areas where loans are hard to come by. It’s attractive to borrowers who are having trouble getting cleared for loans because their financial situation doesn’t appeal to institutional lenders. If you’re a seller with a house in a down market where borrowers are having trouble getting loans approved, offering financing to prospective home owners may be a viable option for you.
How do seller-financed mortgages work?
Both parties, the home buyer and the seller, must execute a promissory note. This promissory note will outline the interest rate, mortgage payment schedule and what happens if the borrowers default. In some states, they will need to record a mortgage – or a “deed of trust”- at the local public records office.
Seller-financed mortgages are often only made for the short term, with a lump sum payment due at the end of the agreement. Most of these agreements are made under the premise that the borrower will be able to refinance the loan before then.
How seller-financing benefits the seller
You may be thinking that all of this sounds too risky for the seller. But what a lot of people don’t know is that the promissory note is an asset, one that can be bought and sold. You can sell the promissory note on the day you close the deal on your home. The new home owners will then have to pay their mortgage to the person or institution you’ve sold the note to. So, you don’t necessarily have to become a lender.
Seller financed mortgages ideally benefit sellers whose mortgages have been paid off or the mortgage can be paid with the down payment. If the house is still under mortgage then the existing lender will have to become a party to the transaction. This will be difficult in markets where credit is tight.
If you’re thinking about entering into a seller-financed real estate deal, your first call should be to your lawyer. You will need help drawing up the contract for the sale and the promissory note. Reporting and paying taxes on these deals also require lots of extensive paperwork, so you’ll need help with that as well.
Here are some other things sellers can do to protect themselves:
Draw up a loan application: You should insist the at the prospective buyers fill out a loan application. Do your due diligence and check all of the information that they provide. You should do a credit check and an employment check. In addition, their financial statements, financial claims and any other background documents should be thoroughly examined. One of the conditions of the contract of sale should be that the deal is only final when the seller approves the buyer’s financial situation. In fact, each aspect of the contract, including the loan amount and interest rate, should be contingent on your approval of the buyer’s financials.
Use the home to secure the loan: The loan should be tied to the property, giving the lender the option to foreclose on the house if the borrower defaults on the loan. You should have the home appraised before you negotiate the terms of the deal to make sure that the purchasing price is equal or higher than the value of the home.
Ask for a down payment: There’s a reason why institutional lenders ask for a down payment. It gives them a financial cushion just in case the lender defaults. It also shows that the buyers are serious. A down payment gives them a stake in the house, making it less likely for them to instantly disappear if they begin to have difficulty making their mortgage payments.
Seller-financed mortgage agreements have their risks. But if you follow the tips in this article, it can be a seamless arrangement. One that benefits both home buyers and sellers.