Home » Uncategorized » Understanding Seller Financing Benefits and Risks

Understanding Seller Financing Benefits and Risks

Seller financing happens when the owner of a property agrees to finance the buyer. As anything it has its pros and cons. This article will discuss some of the benefits and risks/drawbacks for sellers and buyers.

Benefits for sellers

– Seller may be able to sell property faster. The pool of buyers increase significantly when the seller offers seller financing. Many buyers do not qualify for traditional financing and decide to seek seller financing opportunities.

– Seller can usually demand a higher price for his property. Seller financing is a value added benefit to the transaction. Buyers that do not qualify for traditional financing will typically be more flexible and will accept to pay more.

– Seller can defer taxes on the appreciation of the property. As you probably know, sellers pay taxes on the amount the property appreciated since he bought it. When they sell the property outright, they end up having to pay taxes that year. When they finance the transaction, they do not pay taxes on the appreciation until the new owner refinances the mortgage.

– Seller can typically receive a nice return on the money he has invested in the property. Sellers that offer seller financing will typically charge a higher interest rate than the prevailing rates charged by traditional lenders.

– Quicker escrow. Once buyer and seller agree on the terms, the transaction can move forward and close within a few days. Transactions using traditional mortgages still require a few weeks before they can close.

Benefits for buyers

– Opportunity to buy a property even if he does not qualify for a traditional mortgage.

– Lower closing costs. Traditional lenders charge a number of fees when they issue a mortgage. As a general rule, buyers are responsible for paying those fees. In seller financing transactions, sellers will typically charge fewer fees if any.

– Everything is negotiable. Buyer and seller can negotiate down payment, closing costs, interest rate, term, etc. Sometimes a buyer can obtain a lower down payment by agreeing to a higher interest rate, or vice-versa.

– Quicker escrow. As mentioned above, once buyer and seller reach an agreement, we can close within a few days.

Risks and drawbacks for sellers

– Seller does not receive his money until buyer refinance the mortgage few years later.

– Seller is now acting as a bank, with similar responsibilities. He has to collect payment, send past due notice, pay property taxes or confirm that buyer paid them directly, pay homeowner’s insurance or confirm that buyer paid it, etc. To minimize work, seller can hire a company to service the loan.

– If buyer defaults, seller has to initiate foreclosure proceedings in order to take the property back. Foreclosure is a complex process that needs to be executed correctly.

Risks and drawbacks for buyers

– Buyer will need to refinance the mortgage within a specific amount of time. Most sellers will carry the note for 2 to 5 years. Few sellers may go longer than that. However it is very uncommon for sellers to agree to carry the note for 30 years like a traditional mortgage. Buyer will need to pay for the refinance.

– There is a risk that the property may not appraise when buyer tries to refinance. To protect the buyer, the note should have a provision to deal with this situation.

– There is a risk that the buyer may not qualify for a traditional mortgage by the note’s deadline. To protect the buyer, the note should have a provision to deal with this situation. One way to address this risk is to have a provision that allows buyer extra time to qualify.

– Buyers eager to buy a new property, may end up overpaying. In a traditional mortgage, banks will order an appraisal that will provide another layer of protection for the buyer. A typical seller financed transaction will not have an appraisal done. Buyer should be extra cautious.

Seller financing is a wonderful instrument that can benefit both buyers and sellers. However, it is too easy to focus only on the benefits and forget about the risks and drawbacks. Buyers and sellers should invest the time to understand the process and seek advice of a knowledgeable professional.