Are you a seller willing to provide a mortgage to a prospective home purchaser? Or, are you a residential home purchaser able to purchase a home for full price or even a higher offer and seek alternative financing? There is an uptick in seller financing for both parties due to the increase in interest rates to date and lenders becoming more cautious in their underwriting.
While seller financing typically is common in sales of investment properties, seller financing enables home buyers to increase their purchasing power by saving on closing costs or paying lower interests rates compared to lender financing. For sellers, seller financing encourages home buyers to make a full price offer or even a higher offer on their home. It appears to be a win win for both parties.
How does seller financing work?
Picture courtesy Bankrate
The seller provides title to the property to the home buyer at closing, just like a traditional mortgage. However, seller financing benefits buyers who may actually obtain a more generous credit from the seller than they would from a bank, while avoiding closing costs, such as application fees and escrows.
However, by providing title upfront, sellers face a risk when providing financing. Specifically, if the buyer subsequently defaults, the seller may be forced to foreclose on the property. A seller providing such financing may nevertheless do so by carefully vetting the prospective purchaser by requiring a substantial down payment, and considering only those buyers who pay full or above the purchase price. Sellers must also hire competent counsel to ensure conformity with federal laws, called Dodd Frank, that govern these transactions.
Why would a seller provide seller financing?
For those sellers who either own their properties outright or have sufficient funds to pay off their own mortgages, seller financing creates an income stream or similar to an annuity. The key is to make sure that the potential buyer is carefully vetted to decrease the likelihood of a default.
Other instances in which a seller may provide financing include when a seller is motivated to provide financing such as when there have been no offers on the property for a period of time. Likewise, a seller may be motivated to provide financing should the seller receive low offers.
What tips should sellers consider prior to financing their homes?
The following are a few considerations for sellers to consider prior to deciding to finance their property;
- Consult with a tax advisor. Seller financing may be treated as an installment sale for tax purposes which affect capital gains taxes.
- Determine the interest rate. The Internal Revenue Service requires sellers holding a mortgage to charge a minimum interest rate to avoid “imputed interest” rules, which could tax the sellers on interest that they did not actually collect. Again, seeking advice from a tax professional is recommended.
- Minimize seller default situations. In order to decrease the possibility of buyer default, sellers must vet potential buyers to ascertain their credit worthiness by inspecting the buyers’ finances. Sellers should also obtain a down payment high enough to ensure that the risk of buyer default is not high and also to minimize seller risk the seller should have to take back the property.
- Have an attorney to ensure compliance with Dodd Frank.
What does this all mean?
With increased interest rates, buyers are looking for alternative financing for home purchases. Some sellers view seller financing, once they vet a prospective purchaser, as an annuity, with a stream of income over a period of the financing term. Buyers see seller financing as a way to lower overall closing costs. Yet, these transactions work if the buyer has enough of a down payment coupled with a strong credit and financial background. While the issue of attainable housing still remains unresolved, these scenarios suggest creative options to move some properties.
Roy Oppenheim
From The Trenches