Have you ever browsed homes on Zillow, only to see “owner financing available” listed in the description? Owner financing, also known as “seller financing” or “purchase-money mortgages,” is when the owner of the home provides a short-term mortgage loan to the buyer as opposed to the buyer going through traditional means to secure a loan, like a bank. While this is most common during difficult financial times when banks are extra hard on applicants, it’s still used today and is a great opportunity for a seller to increase their wealth by using this strategy and collecting interest over time, just like a bank.
In this article I’ll go through the benefits and challenges of seller financing, its process as well as some important details about seller financing like balloon payments and how to buy or sell a loan to an investor. Many are hesitant about seller financing, but that is only because not many know the details of the deal. Seller financing could be your next great opportunity!
Benefits for a Buyer
If you are a buyer, due to certain life circumstances you may have a difficult time getting a loan from the bank. Perhaps a lapse in employment, bad credit or unclear income trajectory forces a bank to have to say “no.” But never fear! Seller financing is here.
Not only can seller financing save the buyer from a hard situation, but seller financing deals tend to move incredibly quickly, you can close on a house in a little as 14 days.
As a buyer, instead of using your credit to purchase the house, you will need to show proof of income and a down payment to purchase the house. As an average the down payment is about 10% of the purchase price.
This is a great alternative for buying a house, with little to no credit.
Benefits for a Seller
First, offering seller financing may make the home sell faster compared to the others on the market. If the economy is bad or mortgage loans are hard to get in your area, offering seller financing makes your home that much more attractive for a buyer.
You also have the opportunity to make money off of the loan by having an interest rate. As I mentioned earlier, the interest rate would also be on the higher side, since you are taking a risk with the offering of a loan. This is a great opportunity to get a steady cash flow month over month.
Make sure to always get a down payment from the buyer. The higher the down payment the more committed the buyer is to continue making payments.
In my owner finance deals I like to do a 20 or 25 years note, with no balloons, then sell the note to another investor or bank within 24 months. Or, I keep the note for as long as I can to collect a steady cash flow.
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The Seller Financing Process
1.Close the Deal and Promissory Note
I recommend closing all owner finance deals at a title company if you are planning to sell the note at a later time, or you can choose to do a closing outside the title company in order to reduce closing costs and save money. To begin, the seller and buyer will write up a promissory note that includes the details of the deal. What’s the interest rate? What’s the repayment schedule? How long will the loan last? Will there be a balloon payment at the end? What are the consequences of default? This will all be included in the promissory note.
2. Collect Monthly Checks
No matter on the length of the loan, you’ll begin to collect monthly checks from the buyer, just like any mortgage loan. This is a great opportunity for cash flow for your other ventures. Seller financing usually only lasts around 5 years if you do a balloon payment, but if you do this for multiple properties that’s extra money in your pocket than you would get from just selling (because of the interest.)
3. Seller Sells Loan to Investor
Sometimes, but not always, the promissory note is sold to an investor. For some, this is their home, and they need the capital to buy a new house. Or, some just want to move on from the deal.
Balloon Payments
It is common for seller financing to include a balloon payment. A balloon payment is when a short-term loan finishes with a very large payment, a payment many cannot afford. This is to pressure the buyer to refinance their home before the promissory note is completed. Again, seller financing is meant to help a buyer out in a tough spot, temporarily. Not 25 to 30 years like a regular mortgage. It is important to note that balloon payments are illegal in some states. Make sure to look up your state laws before moving forward with one.
As mentioned above, in my owner finance deals, I don’t do balloons payments, just sell the note. That way I make sure my buyers don’t have the pressure of refinance and they can keep the home for as long as they want.
People buy owner finance mainly because they don’t have the credit, and more likely their credit situation won’t improve, so by adding a balloon payment you are setting up your buyers to fail.
The Challenges of Seller Financing
Obviously there are a lot of benefits to seller financing. A buyer can buy a home they wouldn’t be able to get otherwise and the seller is making extra income. That being said, there are some challenges to seller financing.
First, as I alluded to earlier, a seller needs to be able to afford this offering. Seller financing is not a good option if it’s someone’s only home and they need the capital of their current home to sell in order to afford a new home. It’s really most conducive to those who flip homes or have multiple properties.
Second, like any loaning event, the buyer needs to prove that they can pay the seller. They’ll need to make a good argument especially since the banks and mortgage companies denied them. This could be difficult for some.
The buyer will have to provide proof of income, so the seller can make sure they can make the payments.
I use a residential loan mortgage originator (RMLO) to qualify the buyer, and make sure they are a good candidate to buy the house.
On top of that, the buyer will also be paying a higher interest rate than normal. This is not ideal for a person who is in a tough financial situation. However, they might not have any other choice.
Conclusion
Overall, seller financing can be a great opportunity for a seller to increase their cash flow, especially real estate investors. You’re helping a buyer out, you’re making money off the interest and you’re making money off a property that might have taken longer to sell had you gone the normal route and not offered financing. While it’s a very straight forward process, it’s important to look into the details of the laws in your state to see what is legal and what is not legal, like balloon payments.
Are you going to offer seller financing on your next property? Why or why not? Share with me in the comments!