There are a variety of different ways to pay for the purchase of a new home or homestead property. Most of them surround the idea of conventional loans from a bank or other lender. Terms of these loans are normally easy to understand. There is a purchase price and then an interest rate. There may be costs associated with obtaining the loan and a down payment required. There are a variety of different steps that must be taken such as verifying the buyer’s ability to repay the loan and using a title company to research any current liens and loans on the property. Once these steps have been taken the buyer and seller will sign papers along with the bank at the time of closing and a deed will be recorded in the new owner’s name with a lien showing their debt. The seller will be paid and any outstanding loan they might have will be immediately paid off with the remainder of the balance to be seen as profit for the seller.
This is how the normal closing and loan process goes. If you are a buyer it is important that you have conversations with your lender prior to searching for a home so you understand the amount the banks will lend you and at what terms.
If you are a seller of a property then your main concern is to first pay off any debts on the property and then possibly reinvest the profits into a new home or property. Taxes and other issues are concerns but this is the standard method of selling your home.
What Is The Benefit Of Seller Financed Lending For Property Purchases
There are many different circumstances where Seller Financing can be appropriate. Often this occurs when the buyer and seller are related. A parent or family member might have a property that they want to sell and a family member may want to purchase it but because lending would be difficult to obtain the seller accepts a payment system vs full pay out at closing.
Another very common situation where Seller Financing happens is in rural plots of land. When a property does not have a home on it or improvements the lenders tend to shy away from lending to buyers. The reason being is that the Bank does not want to get stuck with the property if the buyer fails to make payments. The historic elements of buying and selling rural property means lenders are already aware of the problem and even if the buyer has good credit and income sources there just might not be lenders willing to even talk about a loan. For this reason Seller Financing is common between strangers but the seller must do due diligence the same way that a bank would when evaluating if a buyer is able to repay the loan.
Rent to Own is another form of Seller Financed Lending where a home owner might allow a tenant to accumulate payment against a property while they are renting and then purchase the home with additional terms attached. This can be beneficial for both parties but the terms of the agreement normally favor the seller if a tenant changes their mind during the agreement. Normally all credit towards the purchase is lost if the buyer or tenant backs out of the purchase.
Important Aspects Of Seller Financing
Every buyer seeking to purchase a property should understand their options and obligations before they start looking at homes. In the case of Seller Financed Lending these obligations might be much higher in some areas of the contract and they should not be ignored.
First is the down payment on the property which will normally be a minimum of 20% or higher. It might not be unexpected that a much larger portion of the purchase price be paid in cash by the buyer because the seller can have their own obligations such as paying off any outstanding debt or the need of a down payment on a new property they are buying. Whatever the reason you can expect a much higher down payment to be required.
The length of the loan will normally be much shorter. You can expect Seller Financed Loans to be in the 5 to 10 year range vs a 30 year loan offered by a Conventional Lender. The reason for this is that the seller normally can not wait 30 years like a corporation can for repayment of the loan. If you are purchasing a property from someone that is 60 years old they can not wait until they are 90 for full repayment.
Interest Rates are likely to be higher than available for a traditional home loan. Although interest rates will be higher they are limited to lending laws in your state. Normally this is 10% for person to person loans where as a bank as we see with credit cards can charge interest rates of 15% to 20% or even higher.
Interest Rates can change as the loan ages. Normally as a method of persuading the buyer to pay off the loan early a seller might change and increase the interest rates on a loan as it gets older. You can expect Jumps in rates at the 5 year point and it is not uncommon to see rates double. Your seller financed rate might start out for the first 5 years at a conventional rate of say 3.5% and then jump to 7% at year 5 to induce the buyer to pay off the loan. This is similar to a ARM loan.
Sellers may require that the buyer inform them of any changes in income such as a layoff or any claims against them or new loans that they acquire such as a construction loan to build a home on the property. Any changes might be reason for foreclosure.
Foreclosing on the property is a last resort of a seller however it is important that they remember this is an option to protect their interest in the property. It will be important for the seller to monitor the financial status of the buyer just like a loan company would.
Buyers must confirm through a Title company that the Seller is able to sell the property free and clear of any debts. This is something that should not be overlooked.
Just like banks sell loans to other lenders Sellers that Finance the loan are able to sell the debt to a third party to obtain quicker payout. Unfortunately you won’t normally get a full return on your debt and can expect anywhere from 60% to possibly 90% depending on the property and the circumstances.
Sellers that finance loans can hire a Loan Servicing Company to collect the payments and manage any other aspects of repayment. Again there are costs involved with this but especially if you are moving out of state it could be in your best interest to have a third party do your collections.
Real Estate Lawyers for both parties is a requirement. You will want to have all of the paperwork reviewed by a lawyer so that any technical aspect can’t cause issues either at the time of sale or in years to come. Normally you can find a Real Estate Lawyer that will charge you a Flat Fee vs Hourly which will be in your favor.
You will also want to cover the possibility if either party dies before the loan is repaid. Will the Seller’s Heirs assume the repayment or will the survivors of the buyer continue payment. These aspects are not ones we want to talk about but because the loan is between individuals and not a entity like a bank survivor ship and rights do come into question.
Final Note
When two parties come together at an agreement for the sale of a piece of property there are many ways to get the sale completed with both parties protected and happy with the results. The main thing is to be open and clear stated when making proposals and writing up documents.
It is very important to find professionals that have a lot of experience when completing a transaction such as Seller Financed Lending because most realtors and real estate lawyers do not deal with these things often enough to make sure mistakes are caught before they happen.