Offering seller financing can be a smart way to sell your home more quickly, especially during a slow market—though it does come with its own set of challenges. If you’re unfamiliar with seller financing (also called owner financing), you’re not alone. It’s a method that’s more often seen in business sales than in residential real estate. However, in a competitive housing market where standing out is key, seller financing might be your opportunity to secure a strong sale price and speed up the transaction. So, what exactly is seller financing, how does it work, and when is it a good idea? Let’s take a closer look.
What is seller financing?
Seller financing, also known as direct owner financing or owner finance, is an agreement in which the seller of a property acts as a lender to the buyer, eliminating the need for a traditional mortgage. In this scenario, the buyer makes monthly payments directly to the seller, which include both principal and interest, according to the terms established in a payment agreement signed by both parties.
Typically, homebuyers secure financing through a bank or traditional lender, where they make their monthly mortgage payments.
In a seller financing arrangement, however, the seller acts as the lender by offering the buyer a short-term loan that covers some or all of the home’s purchase price, excluding the down payment. The buyer then makes monthly payments directly to the seller, which include interest. Both parties sign a promissory note outlining the terms of the loan, such as the repayment schedule and agreed-upon interest rate.
When and for Whom Seller Financing Makes Sense
Seller financing can be a good option in certain market conditions or situations. According to HomeLight’s Top Agent Insights for End of Year 2023 report, real estate agents observed that last year, buyers struggled with high interest rates, prompting agents to suggest that sellers take more proactive measures to entice buyers.
Around 20% of the agents surveyed believe that offering flexible financing options can be effective for selling homes in a slow market. In such a market, seller financing could be beneficial in the following scenarios:
When you prefer receiving income over several years instead of a lump sum: This is often the case for sellers nearing retirement, as steady income provides financial security compared to a one-time payment.
When a perfect buyer doesn’t qualify for traditional financing: This might occur if the buyer is new to the area, going through a divorce, or trying to purchase a property type that is difficult to finance through a bank.
When selling properties like large land parcels or fixer-uppers: For instance, a buyer looking to purchase a large piece of land or an older home requiring significant renovation may struggle with obtaining traditional loans. Perrin Cornell, a real estate agent in East Wenatchee, Washington, explains that this could also apply to land sales where the property’s location or condition makes it hard to secure financing.
When selling a farm: While the federal government is the largest lender for farm financing, these loans can take months or even years to process. Seller financing might be a faster option for sellers who don’t want to wait that long.
In general, seller financing allows you to offer better rates than traditional banks, potentially attracting buyers on a tight budget. For these buyers, lower interest rates could be the deciding factor in choosing your property over others.
Seller Financing Options
There are several ways to structure seller financing:
All-Inclusive Seller Financing Loan: You provide financing for the full purchase price of the house, excluding the down payment.
Junior Seller Financing Loan: You finance a portion of the home’s cost, excluding the down payment. This is typically the difference between the sale price and what a traditional lender is willing to finance.
Land Contract: You and the buyer share ownership, known as “equitable title,” until the full purchase price is paid. While the buyer occupies the home and is responsible for maintenance, taxes, and insurance, the deed doesn’t transfer until the loan is fully paid off.
Lease Option: You lease the property to the buyer for a set period with the promise to sell it to them later. Some or all of the rental payments can be applied toward the purchase price.
Assumable Mortgage: The buyer takes over your existing mortgage with your lender. This option requires approval from the lender.
Risks and challenges of seller financing
One of the main challenges for sellers is that you must own your home outright to offer seller financing. If you still have a mortgage, your lender would need to approve the financing arrangement, which is unlikely.
Assuming you own your home and offer seller financing, once the home sells, you take on the role of the sole lender. This situation works well as long as the buyer continues to make payments. However, if payments stop, you’re left to manage the situation alone, which can be complicated and costly.
If foreclosure becomes necessary, you’ll face significant legal and other fees, along with the time and effort to navigate the foreclosure process. On top of that, you may have to deal with the added challenge of trying to sell a foreclosed home, while also no longer receiving the expected monthly payments.
The responsibility for maintenance, property taxes, and insurance remains yours, even though you’re no longer receiving the expected income. Moreover, during this time, the value of your property might decline, and you’ll face the daunting task of relisting the home at a lower price.
Additional Downsides of Seller Financing
In cases where partial financing is involved with a lending institution and foreclosure occurs, the bank is paid in full first. This means you’ll have to wait for your payment, and that could take a long time.
Even if everything goes smoothly, the tax implications of a seller-financed sale are complex. You’ll need to keep your documentation organized and may want to hire a professional to help with tax filings. Additionally, the rules surrounding the tax-free sale of a primary residence could change based on your situation.
It’s crucial to gather a full loan application from the buyer and verify all relevant documents. As the lender, the responsibility is on you to check everything thoroughly.
Minimizing the Risk of Seller Financing
While seller financing carries risks, these can be mitigated if approached with the same level of professionalism as a financial institution. This includes ensuring that all documents are in order.
Make sure to gather a complete loan application, similar to the thorough process used by banks, and verify the buyer’s financial status. Basic loan applications are available online.
Your contract should specify that the sale is contingent on your approval of the application. Legal assistance may be necessary to ensure everything is done properly.
Ensure that the loan is secured by the property, and you retain the right to foreclose if needed. While you may not want to take the house back, at least you’ll have the option to sell it again if necessary.
Don’t accept a down payment of less than 10% to cover your agent and escrow fees. A buyer with a larger financial commitment is more likely to follow through.
Some experts recommend a down payment of 30% or more to ensure that the buyer is invested enough to avoid walking away from the deal and that the seller has some financial buffer if issues arise.
Be cautious and trust your instincts when selecting a buyer. Avoid rushing into a deal with someone you feel is not a reliable candidate to repay the loan.
If you proceed with seller financing, keep an eye on the property. You don’t want to face unexpected repair costs after a foreclosure.
Work with a Top Agent if Considering Seller Financing
There are many skilled HomeLight agents who specialize in seller financing. If you’re interested in this option, make sure to work with an agent who understands the process and can actively present it to potential buyers.
Let your agent know the terms you’re willing to offer for seller financing, including the details of what you can do for the buyer. The listing should clearly mention “seller financing available,” “owner will carry,” “OWC,” “flexible terms,” “motivated seller,” or “wrap” (for a mortgage wrapped around another).
By observing these terms in local listings, you’ll have a better understanding of the market competition and can evaluate whether the risks of seller financing are worth taking.
