Seller financing refers to obtaining a loan from the seller of a home of going through a bank. Lets discuss the scenarios where this method’s appropriate, along with the advantages and disadvantages for both buyers and sellers.
When to Consider Seller Financing
Seller financing is not very common in a real estate market where sellers have many potential buyers to choose from.
However seller financing tends to become more prevalent in challenging real estate environments when traditional bank loans are harder to secure or when buyers face difficulties that impact their eligibility for bank financing.
For seller financing to be an option sellers need to either own their property or have equity in their home to cover the existing loan upon sale.
For instance if someone is selling their house for $300,000 and still owes $30,000 on their loan they could request a 10% payment from the buyer for seller financing. This down payment would clear the $30,000 debt allowing them to proceed with seller financing, for the remaining $270,000.
If the buyer had a loan balance of $150,000 their 10 percent, down payment would only reduce the loan to $120,000. In cases they would need approval from their lender to offer seller financing until they pay off the remaining $120,000. Obtaining this permission from a lender is highly uncommon.
Buyers typically consider using seller financing when they are unable to qualify for a bank loan. This could be due to issues with their credit history, income level or asset portfolio. It could also be because the property requires repairs that must be completed before a traditional lender will approve the loan.
Seller financing provides buyers with a way to purchase a home without having to meet these requirements of lenders.
Advantages of Seller Financing
Some advantages for buyers opting for seller financing are;
- strict approval processes; Sellers are generally less stringent in their loan approval procedures compared to federal requirements and documentation needed by banks.
- No mortgage insurance for down payments; Bank loans with than 20 percent down often require mortgage insurance that can range from about 0.45 percent, to 1.05 percent of the loan amount.
In the example provided with a $270,000 loan this results in a cost ranging from $101 to $236, for financing.
Sellers who opt for seller financing enjoy advantages;
1. They have control over when the deal closes. Unlike bank financed transactions that depend on the timing and approval of bank loans seller financing allows for a closing process since the sellers act as lenders.
2. It serves as a source of income. Seller financing ensures a income stream instead of a one time payment at closing. This income includes interest earned on top of reclaiming their property equity once the loan is fully paid off.
Benefits that apply to both buyers and sellers include;
1. Reduced closing expenses. With seller financing there are no bank fees involved making the transaction more cost effective, for everyone involved.
2. Properties can be sold “as is”. Seller financing eliminates the need for sellers to make property repairs demanded by banks before finalizing the loan.
3. A dependable method to sell properties to tenants securely.
If the person looking to purchase is currently renting the home they wish to buy they will acquire the property they already reside in. The seller is already familiar, with their payment history and creditworthiness.
Disadvantages of Seller Financing
Drawbacks for buyers opting for seller financing are as follows;
Buyer might unknowingly take on sellers risks. If there are liens or other claims from creditors on the property title that the buyer’s unaware of (or if the seller is unaware) the buyer may inherit these obligations upon becoming the new owner.
Streamlined monthly payment management. Seller financing makes it more challenging to set up payments. There may be inconsistencies in receiving monthly payment statements and updates on loan balances as a private lender lacks a systematic billing process like a bank does.
Drawbacks for sellers using seller financing include;
Reduced cash flow at closing. The seller exchanges a lump sum of cash for payments.
Uncertain income flow. Sellers can never be sure if buyers will make payments over time. Buyers could lose their source of income pass away etc. exposing sellers to risks as banks face.
Common drawbacks, for both buyers and sellers involve;
Lack of defined procedures.
When a bank gives the light for a loan there are federal rules outlining their responsibilities and protections. However when a seller agrees to finance a buyers loan the level of protection, for both parties hinges on the agreements they craft themselves or with help.
The foreclosure process can be lengthy and complex. If the buyer faces difficulties in meeting payments both the buyer and seller may find themselves navigating a foreclosure journey.
Helpful Tips for Seller Financing
It’s advisable not to skimp on assistance, from real estate agents or attorneys. Both buyers and sellers should seek expert advice to safeguard their interests.
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