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Seller Financing

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   Types of Seller Financing Arrangements

Here’s a quick look at some of the most common types of seller financing.

All-inclusive mortgage. In an all-inclusive mortgage or all-inclusive trust deed (AITD), the seller carries the promissory note and mortgage for the entire balance of the home price, less any down payment.

Junior mortgage. Sometimes lenders are reluctant to finance more than 80% of a home’s value. Sellers can potentially extend credit to buyers to make up the difference: The seller can carry a second or “junior” mortgage for the balance of the purchase price, less any down payment. In this case, the seller immediately gets the proceeds from the first mortgage from the buyer’s first mortgage lender. However, the seller’s risk in carrying a second mortgage is that he or she accepts a lower priority should the borrower default. In a foreclosure or repossession, the seller’s second, or junior, the mortgage is paid only after the first mortgage lender is paid off and only if there are sufficient proceeds from the sale. Also, the bank may not agree to make a loan to someone carrying so much debt.

 

Land contract. Land contracts don’t pass title to the buyer, but give the buyer “equitable title,” a temporarily shared ownership. The buyer makes payments to the seller and, after the final payment, the buyer gets the deed.

Lease option. The seller leases the property to the buyer for a contracted term, like an ordinary rental—except that the seller also agrees, in return for an upfront fee, to sell the property to the buyer within some specified time in the future, at agreed-upon terms (possibly including price). Some or all of the rental payments can be credited against the purchase price. Numerous variations exist on lease options.

Assumable mortgage. Assumable mortgages allow the buyer to take the seller’s place on the existing mortgage. Some FHA and VA loans, as well as conventional adjustable mortgage rate (ARM) loans, are assumable, with the bank’s approval.

Getting Professional Help

Both the buyer and seller will likely need an MLO and Real Estate Agent—perhaps both—to write up the contract for the sale of the property, the promissory note, and any other necessary paperwork.

 

  Selling your Mortgage Note For The Highest Price

  • The ideal seller-financed note has an interest rate at least 4% higher than what banks offer, at least 10% equity, and no more than 10 years of payments remaining.(unless inflation hits)
  • Underwrite your borrowers. A loan is only as good as the borrower’s ability to pay. Verify earnings history and their credit report. Check for prior bankruptcies, foreclosures, or evictions. Finally, if they currently rent, verify they’ve been making rent payments on time.
  • Keep PERFECT records. Verifiable payment histories are critical. Use a licensed 3rd party loan servicer or title/escrow company to collect and track payments and MLO to determine DTI LTV so as not to be a predatory lender
  • Safe Deposit Box the original contract. Think of your real estate seller-financed contract as a check someone wrote you. Keep it in a secure place. At closing, it will be given to the closing agent who will then forward it to your Note Buyer.
  • Train your borrower early on. The contract says you’ll charge a late fee for late payments, charge it. Poor habits repeat if you allow them to.
  • Keep track of insurance and taxes. Your loan servicer should confirm every six months that property taxes are being paid, and at each insurance renewal interval that the policy is current.

Check on the property. While it’s technically in the borrower’s hands (you may not enter inside), they still have a responsibility to maintain what serves as collateral for your loan. Look for a roof, broken windows, shingles, or other serious issues which could reduce the home’s value.

Tips to Reduce the Seller’s Risk

Many sellers are reluctant to underwrite a mortgage because they fear that the buyer will default (that is, not make the loan payments).  Take steps to reduce the risk of default. A good professional can help the seller do the following:

Require a loan application.  Insist that the buyer complete a detailed loan application form, and thoroughly verify all information the buyer provides there. That includes running a credit check and vetting employment, assets, financial claims, references, and other background information and documentation.

Approval of the buyer’s finances. The written sales contract—which specifies the terms of the deal along with the loan amount, interest rate, and term—should be made contingent upon the seller’s approval of the buyer’s financial situation.

Loan secured by the home. The loan should be secured by the property so the seller (lender) can foreclose if the buyer defaults. The home should be properly appraised at to confirm that its value is equal to or higher than the purchase price.

Down payment. Institutional lenders ask for down payments to give themselves a cushion against the risk of losing the investment. It also gives

the buyer a stake in the property and makes them less likely to walk away at the first sign of financial trouble. Sellers should do likewise and collect at least 10% of the purchase price. Otherwise, in a soft and falling market, foreclosure could leave the seller with a home that can’t be sold to cover all the costs.

Negotiating 

Seller financing is negotiable. To come up with an interest rate, compare current rates that are not specific to individual lenders. Use services like BankRate check for daily and weekly rates in the area of the property. Be prepared to offer a competitive interest rate, low initial payments, and other concessions to lure buyers.

Sellers typically don’t charge buyers points (each point is 1% of the loan amount), commissions, yield spread premiums, or other mortgage costs, they often can afford to give a buyer a better financing deal than the bank. They can also offer less stringent qualifying criteria and down payment allowances.

The seller must or should not bow to a buyer’s every whim. The seller  has a right to decent return. A favorable mortgage that comes with few costs and lower monthly payments should translate into a fair market value for the home.

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Getting Professional Help

Both the buyer and seller will likely need an MLO and Real Estate Agent—perhaps both—to write up the contract for the sale of the property, the promissory note, and any other necessary paperwork.