A topic that gets discussed in the real estate investing world quite often is “creative financing.” Usually it is discussed as a way to buy and sell real estate outside of the normal method of obtaining a mortgage from a bank or other professional lender. Although there are multiple ways in which you can use creative financing, one of the most popular ways is seller financing. In today’s post, we will explain how seller financing works and how it can be used by investors, home owners, and/or those looking to buy a home.
How Seller Financing Works?
In residential real estate, seller financing is when the seller provides financing for the purchase of the home, which is usually in the form of a loan. Ownership of the home is transferred to the buyer and the seller acts as the bank with the payments going directly from the buyer to the seller. In the right situation, seller financing can be a win-win situation for both parties involved (and if it is not a win-win situation, seller financing probably shouldn’t be used). First, let’s take a look at the how seller financing works for the buyer.
How Seller Financing Works for the Buyer:
- No Credit Issues: Since the seller will be providing the financing, the buyer does not have to go through the process of obtaining a loan at the bank. For most transactions, this means that the buyer’s credit history and score will not be taken into account. For those who can afford a home but cannot get a loan from a bank due to past credit issues, this can obviously be a great benefit.
- Down Payment Flexibility: Another benefit of not dealing with a traditional bank is that you do not have to meet their down payment requirements. With home prices in Ventura County as high as they are, being able to come up with a down payment is what is preventing many potential home owners from affording a home. Since everything in a seller financed deal is negotiable, it is possible that a low (or even no) down payment can be agreed upon with the seller.
- Additional mortgages: For those buy-and-hold investors who use conventional mortgages, there will probably come a time when you become maxed out on the number of mortgages you can obtain. Seller financing is a great way to buy rental properties without having to worry about banks denying you because of too many mortgages.
- Homes that can’t be financed: This one also mainly applies to investors, but seller financing is a great way to buy homes that a bank won’t finance. If there are safety concerns or other reasons that a bank won’t loan on a property, you can avoid this hurdle if the seller is willing to consider seller financing.
How Seller Financing Works for the Seller:
As you can see, this strategy can be an excellent tool for investors and those looking to buy a home to use. But you may be asking yourself how seller financing works for the seller. Although there may be more, here are three big reasons that a seller would want to use seller financing:
- Monthly Income: Depending on your goals, some people might rather get monthly payments than one big lump sum. Folks that are nearing or in retirement may prefer steady monthly payments that pay for their living expenses. Also, those who are savvy in financial matters may have specific reasons for wanting/needing monthly payments rather than one lump sum.
- Better return on their money: After selling a home, some sellers may have nothing to do with the money besides putting it in a bank. With today’s low interest rates, they will be earning next to nothing while their money is in a savings or other type of bank account. By using seller financing, they can negotiate an Annual Percentage Rate (APR) that is higher than what they can get elsewhere and that is secured by a piece of real estate.
- Tax implications: Although this is not our area of expertise, there are different tax implications between getting one lump sum from selling your home and spreading out that money for however many years you negotiate with the seller. In most circumstances, your overall tax burden will be less by spreading the taxes out than if you are taxed on a huge profit. In order to find out how this will affect your personal situation, make sure to contact your Certified Public Accountant (CPA).
Due on Sale Clause
There is one last thing that must be discussed when talking about how seller financing works. In most mortgages, there is a clause written in that gives the bank to right to demand payment in full if the property is sold. This is known as the “due on sale clause” and always must be taken into consideration when doing a seller financed transaction. The key thing to know about this clause is that it gives the bank the right to demand payment in full, it doesn’t say that they will demand it. Most banks will not care as long as they continue to receive timely payments, but there is always the risk that they will care. The only way to guarantee that this will never be an issue is if the home does not have a mortgage and is owned free and clear. Although we did not discuss in much detail how to structure a seller financed deal, it is possible to do even if there is a mortgage. This should only be done if both parties are 100% aware of the risks, and even then, it still should probably be avoided.