Owner Financing: When Sellers Lend Money to Buyers

With credit tight, the housing market glutted, sellers desperate and bargains to be had, more homebuyers and sellers are considering the idea of having all or part of the purchase price of a house financed by the owner. There are pros and cons for buyers and sellers, so here’s the scoop.

Why Seller Financing Now?

“Changes in the market make seller financing very attractive for both buyers and sellers,” says Todd Huettner, a Denver-based mortgage broker. “Many buyers can no longer qualify for an affordable loan, and sellers can be more competitive in a crowded market by offering buyers the option.”

As the economic downturn continues, owner financing will only increase, says Elizabeth Weintraub, homebuying columnist at About.com and a Sacramento real estate agent. “Without a good credit score, buyers are locked out of a mortgage, and many conventional loans now require a down payment of 20 percent of the purchase price,” she says, adding that when interest rates reached 18 percent in the late 1970s and early 1980s, owner financing was often the only game in town.

Advantages of Seller Financing

For buyers:

• It helps alleviate the need for jumbo loans that can hamstring a buyer, says Jamie Katz of J. Edward Company, a real estate firm in St. Paul, Minn.;
• Seller financing can also cover closing costs, which require ready cash that some buyers lack;
• It allows a buyer to purchase a house when there are no other financing options.

For sellers:

• Owners can move a property more quickly;
• A seller can often get a better return on his/her investment than other assets would generate;
• A house becomes more attractive to buyers if they don’t have to worry about obtaining financing.

For everyone involved in a home sale, and the market as a whole:

• The deal can close more quickly;
• A sale means one less vacant house in the neighborhood, which enhances the value of the home and the neighborhood;
• It keeps a house out of foreclosure, which is expensive and can take up to a year to complete.

Disadvantages of Seller Financing

For buyers:

• The seller may not report to the credit bureaus, meaning that timely payments don’t necessarily improve a buyer’s credit score.

For sellers:

• Money is still tied up in real estate;
• The seller is paid over the length of the mortgage instead of in one lump sum;
• If the buyer defaults, the seller is left holding the bag.

Firsthand Experience

Thomas Mirabella decided to offer seller financing in July 2003 to a buyer for his home in Long Island, N.Y. He wanted to diversify his investment portfolio and produce monthly income over a period of time. “Assuming you have a qualified mortgagee, the return is better than interest in a money market or high-yield savings account or a CD,” he said. Mirabella and the buyer agreed to a 30-year fixed-rate mortgage (similar to bank terms)and he has generally been pleased with the results.

When Michael Soon Lee of Dublin, Calif., decided to buy a house in the mid-1990s, he could have gone to a bank, but instead he opted for owner financing. He received an interest rate that was 2 percent below the standard rate at the time for a seven-year, interest-only loan, and he didn’t have to pay any bank fees, which would have cost him an additional $7,200 on top of the loan amount. “It was much faster than going to a conventional lender,” Lee said, adding that he probably would not have qualified for a conventional loan since he owned too many investment properties at the time.

Is Seller Financing Right for You?

There’s no question that the seller assumes more of a risk than the buyer when it comes to owner financing. If you want to sell your home and are thinking about offering financing to a potential buyer, but you’re nervous about the prospect, consider your circumstances.

“Some sellers go for owner financing if they have equity in a house but need to sell because they can no longer afford to keep it,” says Kerry Gelbard, a senior loan consultant with L.A. Mortgage in Encino, Calif. Although it may be risky (after all, even creditworthy owners are defaulting these days), it may be better to run the risk of holding a defaulted loan than losing your home and remaining equity to foreclosure. “Don’t make the loan unless it is a property that you want to own,” he cautions.

Whether you’re a buyer or seller, have an experienced real estate attorney review all documents. As is the case with everything, especially with something as sizable as a real estate investment, proceed with eyes wide open and know the ramifications of your decision before you sign on the dotted line.