What is seller financing and how does it work?
By Bob Walsmith Jr.
Santa Barbara Association of Realtors
The competition in this current housing market is tough. Low supply and high demand are just two factors that make it difficult for many potential buyers to find a home. Not only that, but qualifying for a traditional loan can be difficult, especially with today’s rising interest rates. An option outside the norm is seller financing. With seller financing, the home owner offers a loan to the buyer. So you can avoid the pitfalls and challenges of the traditional mortgage experience. Seller financing offers several benefits, such as lower closing costs. But they also come with their own challenges. Here’s how this loan process works and if it’s right for you.
What is seller financing?
Seller financing is an alternative way for a buyer to purchase their home. Essentially, the seller becomes the lender and extends credit to the buyer so they can cover the purchase price of the home (excluding the down payment). Thus, you effectively eliminate the middleman, i.e. a traditional lender. The seller oversees the debt instead.
How does seller financing work?
When you enter into a seller financing agreement, the seller acts as the lender. So you, the buyer, buy a home from the seller without the involvement of a bank, credit union, or other traditional lenders. The seller only extends credit to the buyer, but not in cash. Once they do, the buyer makes regular payments to the seller. They do this until they completely repay the balance owing.
Although this agreement does not involve lending institutions, the buyer and seller often use other professional help. Often, they rely on lawyers and Realtors® to facilitate the purchase. Professionals in these fields also take the initiative to generate the terms of the agreement. However, the buyer and seller can negotiate factors such as the term of the loan or the interest rate. Seller financing generally works in two ways.
First, the buyer receives the title deed after agreeing to pay the loan offered by the seller. The buyer can then refinance or sell the property but continue to make payments to the seller according to their agreement.
Or, second, the seller retains title until the buyer repays the loan in full. Only then do they receive the title.
In either case, the seller often asks the buyer to fill out an application, go through a credit check, and offer a down payment. The seller may also require certain requirements, such as a home appraisal. Or they may insist on retaining the right to seize the property if the buyer defaults.
If both parties agree, they must sign a promissory note containing the terms of this loan. Then they file a mortgage (or deed of trust in some states) with the local public records authorities.
Is seller financing right for me?
Today’s housing market is very competitive. So you may find your dream home, but it is out of your price range. Or, maybe you’re struggling to qualify for a traditional loan. Either way, seller financing can open the door to home ownership for you. And you’d also have potentially advantageous terms, such as a low interest rate, low minimum down payment, and lower closing costs.
But seller financing comes with risks. Contracts may include unfavorable terms, such as a higher interest rate or too short a repayment period.
If you’re struggling to meet the criteria for a conventional loan, consider all of your options. Vendor financing isn’t the only router. There are other types of loans with relatively lenient requirements.
Although it can be difficult to find the perfect loan, you should not rush into a loan agreement. Seller financing may be suitable for some buyers. But it strongly depends on the seller and the conditions he offers. Before exploring this option, consider hiring a lawyer. They can ensure that your rights as a buyer are respected. Or they can help you leave if negotiation is impossible. Remember to explore all of your options before deciding, though. There are other loans with lower credit requirements, which may make more sense to you.
Bob Walsmith Jr. is a Southern California native and Realtor® at Berkshire Hathaway HomeServices California Properties in Santa Barbara. During his work with the Santa Barbara Association of Realtors, Bob has served on the CORE Committee, the Education Committee, served as Chair of the Budget and Finance Committee and the Multiple Listing Service Committee. He is also a member of the board of directors of the Alpha Resource Center in Santa Barbara. Bob lives in Goleta with his beautiful wife Julie. When he’s not working, Bob enjoys golfing, tasting fine wine, eating well and walking our beautiful coastline. Bob can be reached at 805.720.5362 and/or [email protected]