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When Seller Financing Is Preferred To A Traditional Mortgage
It is amazing that a simple activity of getting money to buy a house can be demarcated into so many categories. Just the subject of mortgage alone has seen 500-page books being written and entire careers built around it. And this subject alone can be broken down into dozens of other categories where specialists make it their sole expertise in making a living. And then there is the 500lb gorilla which is seller financing.
When a bank declines your mortgage application, it does not spell the end of your goal of buying a house. Even if a private broker runs from you, it is not the end. It is actually just a trigger to unlock the door towards alternative ways of financing real estate. Seller financing is a useful tool to help home buyers complete a deal which they otherwise would not be able to close. For hardcore investors, seller financing can in fact be their first choice of funding.
In seller financing, the seller basically becomes the lender to the buyer. The buyer would make payments to the seller instead of a bank in a traditional mortgage. Financing can be arrange for the whole loan or just part of it. There are no special conditions that would put the ownership of the property in doubt. The buyer would have his name on the deed.
As regular home owners become more financially savvy, more and more are receptive to the idea of financing the buyers’ purchases themselves. This is because the returns on doing it so much better than many other types of investments. Would you rather get 1% on a time-deposit or 5% from being a lender?
But the advantages are no limited to the seller. The buyer can reap benefits as well by going this route. For starters, he will not have to subject himself to outrageous administrative fees or private mortgage insurance. And if the buyer is paying 5% on seller financing, it sure as hell beats 15% by going with a bad credit mortgage. He would also side-step the high pressure salesmen from predatory loan operators. And finally, closing costs for seller financed transactions are generally lower than that of a transaction with a traditional mortgage.
You might ask why would a seller take on the risks by offering financing? Well, it could be because of a number of factors. But the most common one is that he knows the best chance of pushing the sale through is via seller financing. Here are some reasons why that might be so.
- The classification of the property may be one that is shunned by the banks. This could be for a variety of reasons including it being in an undesirable area, the remaining lease is insufficient to match a reasonable mortgage tenor, the size of the house is simply too small to be meaningful.
- The house has been in the market for so long that even the valuation report had expired. This usually means that the property is not as marketable as the seller first thought.
- The owner has not met requirements of mortgage lenders.
- The seller is under certain circumstances which requires him to sell the house as soon as possible. This could be due to impending foreclosure, personal emergencies or other problems.
- The seller needs quick funds for other investments or his business.
- Owner has a sudden preference for interest income instead of rental income. This is common for retirees who no longer has the enthusiasm to manage a rental property themselves. Being a landlord can be stressful both mentally and physically.
For a buyer, here are some advantages of seller financing.
- The buyer often only has to put down a minimum amount for down payment. In many cases, they can even put no money down. But sellers usually want to see at least some form of financial commitment to the purchase. 10% to 20% is usually enough to convince them so.
- Buyer does not have to go through the long-winded process of loan assessment. It is not surprising to find sellers who don’t even conduct a credit check on the buyer they are lending to. But even the happy-go-lucky home owner will at least do a check of bankruptcy records.
- If you go to a traditional lender, you can be sure that one of their requirements is to have a substantial personal income that is enough to comfortably pay for the monthly mortgage. A seller won’t have such a requirement to reject you outright. If you are an investor, they would simply have an agreement with you that rental proceeds will be used to fund the repayments.
- More flexible terms. Unlike conventional lenders who would not negotiate terms at all, a buyer can propose any terms to the seller and seek common ground to compromise. For example, if you receive a big bonus check each year-end, you can propose that you make a bigger lump payment each year without incurring any penalties from partial redemption.
- Lesser documentation and closing costs. There are no hundred-page documents to go through as you effectively cut off a whole host of middlemen by going this route of financing. You cut off extra costs and tedious paperwork.
Because the terms of seller financing can be flexible, buyers or sellers can insert conditions into the agreement contract which you would never have heard of. Expect the unexpected. For example, a buyer may request that no payments are required in the first year, or that interest rates will reduce year-on-year. Whereas the seller might insert clauses that prevent the buyer from selling the property within a stipulated period.
Although seller financing can remove a number of professionals in the value chain, it does not remove the need to hire them altogether. You still need a good lawyer to vet through documents, a proper appraiser to put a credible valuation on the house, and professional services to handle payments, etc. You are just replacing the mortgage, not replace the way you buy properties.