You have multiple options when buying a home. You can buy it outright with cash. Not many people fall into this category, though. You can also take out a mortgage with a bank. Lastly, you can obtain a seller-financed mortgage. The seller provides the funds in this unique mortgage. Because of its unique properties, you should know the ins and outs of this method if you have the option to use it.
What is a Seller-Financed Mortgage?
A seller-financed mortgage, as the name suggests, is funding provided by the seller. Rather than a lender providing the funds, the seller does. But the seller doesn’t transfer funds to anyone. Instead, he provides a promissory note and Deed of Trust. You sign both documents and the seller gives you the home. Usually, sellers require some type of down payment. You pay the cash directly to the seller.
A major difference with seller financing is the terms. Normally, buyers take out a 30-year mortgage. It’s the most affordable term in most cases. With a bank, you have 30 years to pay the loan back. A seller-financed loan, however, usually has a balloon term. The loan may be amortized over 30 years, but it becomes due and payable within 5 or 10 years. This is much more manageable for the seller. Waiting 30 years for full payment could be too long for a seller. A bank can go on forever; unfortunately, a person can’t.
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What to Know About the Balloon Payment
You should pay careful attention to the terms of the balloon payment. It makes sense for the seller. Who wants to wait 30 years to make a profit? Seller financing helps sell a home faster, but it doesn’t do much good if the seller must wait for his money. The balloon payment helps make the process possible. What happens at the end of the term, though? You owe the full amount. Let’s say you still owe $150,000. Where will you come up with that kind of money? You have 2 options:
- Pay the loan in full with cash
- Refinance the loan with a bank
Most people opt for the latter. They take the 5 years of standard payments to fix up their credit and save money. Hopefully, before the balloon term is up, they’ve fixed their credit situation. This may allow them to qualify for a mortgage through a bank. The seller then receives full payment and you start a new mortgage.
Benefits of the Seller Financed Loan
As a buyer, you realize many benefits from the seller-financed mortgage including:
- Fewer restrictions for qualifying for the loan – Sellers can make up their own requirements
- Lower fees – Sellers often don’t charge any closing fees; they only require the initial down payment
- Time to repair your credit – You can own a home and fix your credit at the same time without paying high interest rates or fees
The seller also realizes benefits by offering seller financing including:
- Sell the home faster in a slow market
- Make a higher profit on the home from the interest charged
Qualifying for Seller Financed Loans
A proper seller will still require you to qualify for the loan. They may overlook certain factors a lender wouldn’t accept. But, a seller should still evaluate your situation. A seller should:
- Require completion of a loan application – This helps the lender see your financial situation. This includes your income, assets, and liabilities.
- Verify your credit score by pulling your credit report.
- Verify your income by contacting your employer.
- Verify your assets by requesting copies of your bank statements.
- Require a specific down payment, 10% is usually the minimum required.
In addition, sellers should secure the assistance of a professional. A real estate agent or lawyer can help the seller create a Promissory Note and Deed of Trust. The deed must be recorded in the county the home resides. The lawyer can help make sure all legal aspects of the transaction are covered and everyone’s rights are met.
Sellers have choices when collecting payments. A savvy seller will collect the payments on his own. With the help of his attorney, he will know his rights and when he can exercise them. With a Deed of Trust and Promissory Note, the home is the loan’s collateral. If you stop making payments, the seller can take possession of the home again.
Some sellers opt to hire a loan servicing company. They are responsible for sending you bills and notices as well as collecting payment. The seller pays a small fee to the company for this service, which cuts into their profits, though.
Should You Take Seller Financing?
There are pros and cons for buyers taking seller financing. If you can’t secure a loan the traditional way, it obviously gives you the opportunity to own a home. But, you must consider the balloon payment requirement very carefully. You don’t know what could happen in the future. What if you can’t secure financing from a traditional bank? You’ll be on the hook for a large sum of money that you can’t pay. This could force you to go into foreclosure. This ruins your chances of securing financing in the near future. It might even leave you right back where you started.
The Bottom Line
If you decide to take advantage of a seller-financed mortgage, consult with an attorney, real estate agent, and tax advisor. This way you know where you stand. The attorney can make sure all aspects of the loan are fair to both parties. The real estate agent can make sure you pay a fair amount for the home. Finally, the tax advisor can make sure you understand the tax implications of the sale/purchase of the home.
Make sure you understand the full implications of the loan and what you owe as a balloon payment. Work closely with a professional throughout the loan’s term to make sure you can get the financing you need to pay off the loan.
If it all works, you and the seller have a lot to gain from the seller-financed mortgage!
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