Sellers will often earn a greater amount of interest by financing a buyer than they could earn by investing in other ventures. Seller-financed deals often have higher interest rates than conventional mortgages because they are riskier deals. If the person you are working with had a high credit score, job stability or a large enough down payment, they would have gotten a conventional loan instead. This person came to you because the bank deemed them to be too risky.
One of the risks is that the buyer could stop making payments and force you to foreclose on them, which could take months and cost a decent amount of money. Nevertheless, if a seller successfully forecloses on a buyer, the seller will get the house back and keep the money invested in it thus far.
This is often the case because the home serves as collateral for the loan. The loan is often for a greater amount than the home is worth due to interest payments.
Seller-financed deals are often balloon loans, meaning the buyer primarily pays interest for the first five years and then pays off the rest of the loan in one lump sum at the end of the five years. Thus, when the buyer forecloses in a seller-financed deal the re-acquisition of the home often serves as the compensation owed.
On the negative side, if you get the home back after foreclosure, it may not be in the same condition as when you sold it.
Also, the person you’re working with could always get a second mortgage on the property without your permission or incur liens on the property. If that happens, you might be bumped to a lower priority level and not have first access to the money you're owed. If the bank or some other entity takes possession of the home, you have no secure way of getting your money back. While it’s safe to assume that a bank would not want to lend to someone with so much debt, you’ll want to consult with a lawyer to figure out how to prevent this circumstance.
This works better when you don’t have a mortgage on the property. When you sell your home, you typically use the money you make to pay off the rest of your mortgage. However, when you’re the one financing the purchase, you don’t get a lump sum of money. Therefore, you may not have a way to pay back the bank if the buyer’s down payment doesn’t cover what you owe.
More so, the bank already considered the person you’re lending to a risky person to lend to. So, why would they trust them to pay you in time for you to pay them a monthly payment?
Tips for Sellers Considering Owner Financing
If you decide to do finance someone in the purchase of your home it is important to protect yourself. Follow these four tips to give yourself the best possible chance:
- Work with a real estate attorney. You want to make sure this deal is entirely binding. An experienced attorney can tell you how to prevent situations through which you could lose your money.
- Require a downpayment from the buyer of at least 10 percent. Charging more than that would not be a bad idea either. This person is a risky investment. They need to show you that they are financially committed to this deal. Additionally, you need to have as much compensation up front as possible in case something goes wrong.
- Run a credit check on the prospective buyer and discuss the derogatory marks and late payments that come up. You want to know why this person’s credit score is low. If it’s because they’re young and just getting started, you may consider them more reliable than if it’s because they have defaulted on payments in the past.
- Ask for references. You want proof that this person is capable of making payments in a timely manner. Past landlords can attest to that. You also want proof that they will have the means to make payments for a significant amount of time. A kind letter from their boss could indicate income stability.
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