Seller’s creative finance is a private loan provided by a seller of a property to the purchaser. The buyer will make a down payment to the seller and also will make periodic instalments in a specific time (usually monthly) on agreed interest rate and terms until the mortgage be fully repaid or refinanced. An owner’s financed mortgage could be a first or second lien in many varieties of forms.
In a seller’s finance, the loan is secured by the property sold as collateral, and in the event that the buyer defaults, the property is re-possessed by the seller on the same fashion as it would be by a bank in a foreclosure transaction.
To the seller this is an investment in which the return is guaranteed. For the buyer it is also beneficial because he/she will not have to apply to the bank for a loan, and both, the buyer and the seller, save substantially in closing costs expenses.
If a seller does not need all the proceeds from the sale right away, financing a mortgage is an excellent investment, when it is compared to other investment vehicles available on the market. An investor, who puts his/her capital in the stock market, might get a 6% return, maybe a little more- or he/she could lose 5, 10, 20%, or all of it. By contrast, owner’s financing gives the seller a guaranteed return of whatever the interest rate on the loan is.
Furthermore, a seller who owner-finances can charge a more higher interest rate than banks, because often it makes the deal attractive to the buyer, especially if the buyer couldn’t qualify for a regular bank’s loan.
The main risk to the seller is when the buyer fails to make the instalment payments, but then the seller can reclaim the house (the collateral on the loan), sell it and get his/her money back.
Currently, there is in existence a secondary market for seller’s finance debt’s instruments. It’s composed by the most renowned banks, companies and private investors, which are avid purchasers of debt’s instruments. Through these channels any seller could cash their invested capital whenever he/she needs it, at a discounted price.
This activity is also known as note brokering. (Government’s secondary market) are cutting their losses, reducing risks and loan activity, the creation of the this private secondary market is starting as a new source of funds for mortgages.
Benefits in generating an owner’s finance mortgage:
• Both, buyer and seller save substantially in closing costs.
• Interest, and general terms, can be negotiated between the parties.
• Appliances and other items can also be negotiated.
• The buyer does not have to qualify for the loan.
• The seller can receive a higher yield, by receiving equity combined with interest.
• The buyer does not have to pay PMI (mortgage insurance premiums).
• The seller can negotiate a higher selling price.
• The property could be sold “as-is,” so there is not a need for repairs.
Seller’s steps to finance a mortgage:
• Down payment. Get at least 10% down; 20-25% is ideal.
• Credit score. Review buyer’s credit score. Analyse previous recurring commitments in the buyer’s credit report, and then request the sufficient down to reduce the monthly amount, to a payment which accommodates the buyer to safety handle the regular payments.
• Interest rates. Typical 250-300 basis points higher than banks.
• Amortisation. This is the time period that it would take to pay out the note. Avoid making interest-only notes. Also it’s more secure to make it monthly instalments.
• Balloon date. It is the date specified when the balance of the note is to be paid in full. Many sellers create balloon payments based on their own need for cash, but the balloon payment should be set at a time frame when it is feasible that a loan could be refinanced by the outside community, as a rule of thumb, payment must be set at one third of the amortisation's duration.
• Paid-history documentation. Seller and buyer must maintain records of payments. Photocopies of payments checks, etc.
• Personal guarantees. It will be necessary when the purchaser is a corporation.
Buyer’s steps to a seller’s finance mortgage:
• Typically a seller who has a small mortgage balance, or one who owns a house “free and clear,” or one who the existing mortgage is assumable, is an excellent candidate for seller’s financing. For a person that is about to retire or a retiree, an instalment loan is an excellent way to make their financial future more stable.
• Get an experienced Realtor who is able to explain to the seller the benefits of selling his/her property under seller’s finance terms.
• The purchase agreement must display clearly the terms of the sale, as well as, the financing terms, (interest rates to be paid, down payment, how long the financing terms, etc.)
• Open an escrow account with an attorney or title company. The attorney must draw the financial documents and serve as a trustee for handling the payments after closing, if the arrangement requires the use of a trustee.
Security tips to use before committing to any deal in writing:
• The buyer must require a market analysis of the value of the property. The buyer must include an appraisal contingency in the contract.
• The seller must request a credit report on the buyer.
• Interest paid to the seller is deductible for the buyer in his/her tax returns. Must consult an accountant.
• Both, buyer and seller must consult an attorney.