What Is Seller Financing? The (ULTIMATE) Guide

Today’s inflationary economy has made it increasingly difficult for the millions of Americans who hope to buy a home over the next 12 months. Macroeconomic headwinds, higher interest rates, and declining loan originations have held mortgage credit availability to its lowest level in a decade, according to the Mortgage Bankers Association.

Yet, despite mounting homebuying challenges, seller financing agreements are doing their part to help everyone fulfill their dream of homeownership.     

Seller financing agreements are becoming a more integral component of the national real estate industry, but they can’t help anyone who isn’t aware of their existence. As a result, we have meticulously compiled everything there is to know about seller financing in this guide, including:

• What Is Seller Financing?
• What Is Seller Financing Real Estate?
• How Does Seller Financing Work?
• Types Of Seller Financing Agreements
• How To Find Seller Financing Homes For Sale
• How To Structure A Seller Financing Deal
• Is Seller Financing A Good Idea?
• What Are The Cons Of Seller Financing?
• Seller Financing FAQs
• Final Thoughts On Seller Financing

What Is Seller Financing?

Seller financing is a binding agreement between two parties in a transaction to avoid the use of a conventional loan; in fact, it looks to avoid the use of a lending institution altogether. Instead of relying on a third party, as its name suggests, seller financing places the seller squarely in the lender’s shoes, permitting them to act as the bank and provide the buyer (also the borrower) with the necessary funds to close the deal.  

Otherwise known as a purchase-money mortgage or owner financing, seller financing is typically reserved for titled assets with higher price tags. Automobiles, antiques, and works of art are the most common items purchased with this alternative form of financing, but there’s an entire asset class primed to benefit from cutting out the middleman: real estate.

What Is Seller Financing Real Estate?

Seller financing real estate agreements are a form of alternative financing that offers potential buyers the ability to purchase a home they may have otherwise been unable to. Unlike other financing options, however, seller financing agreements call upon the owner of the home to act as the mortgage lender and extend credit to the buyer.

The seller will finance the purchase price of their own home, minus any down payment that is made. The buyer will then be expected to make any payments agreed upon in the terms set forth by a promissory note. Once the final payment is made, the buyer will receive the title to the property (unless they refinance with a traditional bank).  

How Does Seller Financing Work?

Seller financing real estate deals aren’t all that different from applying for traditional mortgages; each option is merely a different means to the same end. Both sources of capital are designed to give buyers the money they need to purchase a house — the only difference is where the money is coming from and the underwriting guiding the process.

When sellers agree to finance a deal they are essentially agreeing to play the role of a traditional bank. In doing so, the seller will extend the buyer enough credit to buy the subject property, less the upfront down payment. The total purchase price — along with the interest rate, repayment schedule, default consequences, and other important underwriting factors — is contained in a promissory note that each party will agree to and sign. The resulting mortgage and terms (otherwise known as a “deed of trust” in some states) are then confirmed and recorded with the appropriate municipal authority.

Once all of the terms are agreed upon and documented in the appropriate places, the buyer will typically move into the home and begin making payments (usually with interest) per the predetermined amortization schedule.

Due to the nature of these agreements — and the unwillingness of most owners to wait upwards of 30 years to realize their full return — terms are relatively short. While most owner-financed deals are underwritten with a 30-year amortization, they rarely reach full term. Instead, owners will typically include a large balloon payment due in the first five years, only to expect the home to appreciate or the buyer’s financial situation to improve enough to warrant a subsequent refinance with a more traditional lender. When all is said and done, the length of the agreement between the buyer and seller is usually short-term.

To be clear, owner-financed deals are not a luxury afforded to everyone. More often than not, they are only available to those who own their home free and clear of a mortgage. That’s not to say anyone who is still paying premiums can’t offer to finance the deal, but rather that they will need to receive approval from the existing loan provider. In tight credit environments, few lenders would be willing to take on such a risk, but there are always exceptions.

Read Also: Private Money Lenders: The (ULTIMATE) Guide

Types Of Seller Financing Agreements

Owner financing is an invaluable tool extended to both buyers and sellers, but it is not the only type of loan where the lender and the owner are one and the same.

Here’s a list of similar seller financing agreements that may be worth your consideration:

• All-Inclusive Mortgages: True to its name, all-inclusive agreements will witness the homeowner carry both the promissory note and the mortgage balance (minus the down payment) during the entirety of the payment period.
• Junior Mortgages: If the buyer can’t secure enough financing through a traditional mortgage, the homeowner may extend their credit to make up for the difference in the form of a junior (or second) mortgage.
• Holding Mortgages: A non-conforming loan in the same vein as owner financing, holding mortgages allow owners to act as the bank by extending credit to the buyer to finance the purchase.
• Land Contracts: If the buyer opts for a land contract, they will be required to pay the owner in installments, not unlike a traditional loan. While land contracts won’t pass the title to the buyer, they do provide the benefit of shared ownership for a brief period of time. Otherwise known as equitable title, the buyer will maintain temporary ownership until the final payment is made, upon which they will receive the deed.
• Lease Options: Often referred to as a lease-purchase agreement, lease options will allow the seller to rent the property to the buyer for a contracted term. Lease options work a lot like an ordinary rental lease, but the “renter” is given the option to buy the property at a later date, with most or all of the rental payments going toward the purchase price.
• Assumable Mortgages: Under an assumable mortgage, the buyer may take the seller’s place on the existing mortgage. Consequently, some of today’s most popular loan options are assumable. With a bank’s approval, some Federal Housing Administration (FHA) loans, Veterans Affairs (VA) loans, and conventional adjustable rate mortgages (ARMs) may be assumable.

How To Find Seller Financing Homes For Sale

While growing in popularity, the overwhelming majority of homes for sale on today’s market do not advertise the seller is willing to finance impending sales. Most homeowners don’t even know what owner financing is, or why they should even entertain the idea of acting like a bank.

It can be more difficult to find listings that are willing to sidestep conventional mortgages and deal directly with impending buyers. To increase your odds of finding seller-financed homes, you may want to look into the following strategies:

• Specialized Listing Websites: Popular websites like Redfin and Zillow allow buyers to filter results by many categories, not the least of which include homes being sold by the owners.
• Work With A Real Estate Professional: Despite the advent of technology, truly great Realtors and real estate agents are worth their weight in gold. Working with a real estate professional who is in tune with the local market can easily reveal any owners willing to finance the sale of their property.
• Public Multiple Listing Service (MLS) Websites: The MLS is reserved for Realtors and real estate agents, but some counties allow public access to their listings. While there’s no guarantee your county grants public access, it can’t hurt to look. In the event, you can browse listings, and keep an eye out owner financed homes in the comments section of each property.
• Follow Up With For Sale By Owner (FSBO) Signs: Keep an eye out for signs in your market that say “for sale by owner.” At the very least, homeowners going the “do it yourself” route may be more inclined to offer their financing.
• Contact Rental Property Owners: Homeowners who aren’t living in the subject property may be more willing to exercise a lease option. Therefore, don’t relegate your search to homes that are for sale. You may have more luck searching nearby rentals.
• Try Asking: Again, most homeowners don’t even know what owner financing is. Consequently, it’s reasonable to assume many sellers would consider owner financing if they were made aware of its advantages. At the very least, it doesn’t hurt to ask; you will never know until you try.

Read Also: How To Get MLS Access: The (Ultimate) Guide

How To Structure A Seller Financing Deal

Not unlike every other type of real estate transaction, an owner-financed agreement needs to be accompanied by the appropriate underwriting and documentation; there’s simply too much at stake not to take the necessary precautions.

That said, the best way to structure an agreement is entirely dependent on each side’s specific wants and needs; just know that there are three popular ways to go about doing so:

• Promissory Notes & Mortgages (Or Deeds Of Trust): Similar to its conventional counterparts, this structure will have each party agree to the terms of a promissory note. Similar to a mortgage, a promissory note will detail all the terms each party must abide by. The note is then secured against the house by using it as collateral. The buyer’s name will appear on the title and be recorded with the proper authorities.
• Transfer The Deed Upon Final Payment: Both parties in a seller-financed transaction may also agree to structure the agreement like a land contract. Otherwise known as a contract for deed, land contracts will have the owner hold the deed until the final payment is made, or until the loan is refinanced with a more traditional lender.
• Exercise A Lease Option: Also known as rent-to-own, lease options allow the buyer to act as a renter while they make payments. If the lease option is exercised, the buyer may purchase the home, less any rents or balloon payments that have already been applied to the purchase price.

Structuring a seller-financed agreement requires acute attention to detail. For anyone less than comfortable drafting a legal document, enlist the services of a real estate attorney. A qualified professional will make sure everything is done correctly and promptly.

Is Seller Financing A Good Idea?

There isn’t a universal scenario that can broadly claim that seller-financed arrangements are a good idea. Instead, it must be viewed on a case-by-case basis. After all, not all owner financing scenarios are created equal; some buyers and sellers will inherently benefit from it and others won’t.

Let’s take a closer look at some examples of when it is a good idea for sellers to provide financing for buyers.

Offering seller financing is a good idea for owners when:

• They want to sell a property “as-is,” without having to jump through the hoops associated with most lenders’ requirements.
• They are comfortable trading an immediate lump-sum payment for years of cash flow, which can amount to a higher return with interest.
• They are having a hard time finding buyers who qualify for a conventional loan.
• They need to close fast and avoid the lengthy mortgage process.
• They can retain the title of the property and installment payments when a buyer defaults.
• They know the buyer pays all their bills on time.

Accepting a seller-financed agreement is a good idea for buyers when:

• They can’t receive approval for a conventional loan through a credit check.
• They want to buy a home that’s more than they were approved for.
• They would prefer a shorter closing period that doesn’t involve strict underwriting.
• They don’t want to pay appraisal costs, closing costs, bank fees, and inspection costs.
• They can’t come up with the twenty percent down payment to avoid private mortgage insurance.
• They are comfortable exercising a lease option to see if the property is right for them before they buy.

What Are The Cons Of Seller Financing?

Owner financing certainly has its place in today’s market, especially when many buyers are finding it difficult to secure a conventional mortgage. Whether it’s historic appreciation rates or household debt in the United States sitting just shy of $17 trillion, today’s macroeconomic headwinds are proving to be a significant obstacle for potential homebuyers.

Fortunately, many people have been able to capitalize on seller-financed arrangements to realize their dreams of homeownership. Still, there are drawbacks to every form of financing, and seller financing is no exception.

The disadvantages of seller financing for buyers include, but are not limited to:

• Higher interest rates to offset the seller’s exposure to risk
• Significant balloon payments
• Not all sellers are willing to provide financing, limiting buying options
• A poor credit score can disqualify buyers if the seller deems them risky enough
• The inclusion of a “due-on-sale” clause in many mortgages may prevent many sellers from offering owner financing

The disadvantages of seller financing for sellers include, but are not limited to:

• Exposure to more risk than if the buyer uses a conventional loan
• In the event of a default or foreclosure, the seller is still responsible for maintenance and upkeep
• Federal law may prevent sellers from even offering owner financing or collecting balloon payments
• Federal law may require owner-financed agreements to enlist the services of a mortgage loan originator
• The chance of paying capital gains on the sale of the home

Seller Financing FAQs

The same versatility that makes owner financing such a great ally in real estate transactions is also the cause of a lot of confusion. It is worth noting, however, that familiarizing yourself with this alternative form of financing doesn’t need to be intimidating.

Instead, build a solid foundation by going over the answers to some of the most frequently asked questions about owner financing.

What Are Typical Terms For Seller Financing?

When drafting an agreement, the more comprehensive the literature is, the better. To make sure you don’t leave anything out, make sure you at least include these common loan terms:

• Balloon payment details
• Down payment
• Interest rate
• Loan amount
• Monthly payments
• Sale price
• Tax and insurance payments
• Term and amortization schedule
• Any other terms you deem necessary

Who Holds The Title In Seller Financing?

There are many types of agreements, but the owner of the property usually retains the title during the amortization period. Maintaining control over the title provides the owner with leverage and gives the buyer incentive to comply with payment obligations.

Once the final payment has been made, any liens against the title will be dropped and the owner will transfer the title to the buyer.

What Is An Example Of Seller Financing?

Let’s say, for example, a homebuyer is in the market to purchase a home somewhere in the neighborhood for $150,000. Their initial attempt to secure a conventional loan was rejected because their debt-to-income ratio was slightly off balance. This particular person makes enough money to cover monthly payments on a $150,000 home (and a pretty sizable $95,000 down payment), but the bank viewed the debt as too much of a red flag.

As a result, the homebuyer approached the owner of a property for sale and suggested they agree to seller financing terms. Interested in the prospect of collecting monthly payments (with interest), the owner agreed to finance the home themselves, less the $95,000 down payment.

The owner agreed to finance the remaining $55,000 at a 7.0% rate. The agreed-upon term was for five years, amortized over a 20-year period. At that rate, the seller would receive about $426 a month and a balloon payment of about $47,000 at the end of five years. To sweeten the pot, the buyer also agrees to pay any additional property taxes and insurance fees.

The buyer is given the title to the property at the closing table, but it is “subject to” the seller’s mortgage. It isn’t until the buyer makes all the necessary payments that the lien is released and they own the title free and clear.

Final Thoughts On Seller Financing

Seller financing arrangements are designed to help democratize homeownership. Along with every other form of alternative financing, owner financing offers buyers the ability to purchase a home they may have otherwise been unable to buy.

At the very least, the ability to finance a home through the owner gives buyers another avenue to explore. That said, the unique arrangement is not without risk, so it’s in your best interest to learn as much as you can about the process before leaping yourself.