What is home seller financing?
Seller financing simply means that the owner of the property is willing to finance the purchase. So a buyer who can’t pay cash does not need to get a mortgage from a bank or other lender.
Also called a “seller carry,” or “seller carryback,” this option becomes more popular when mortgage rates are rising, home values are soaring, or both. There are several benefits:
- The seller may be able to beat out competition for buyers by offering to finance
- The buyer may be able to save on the lender costs and third-party fees
- The buyer might benefit from an easier qualification process
- The seller may be able to get a higher price for the property and earn interest on the loan
It all sounds very good in theory. In practice, seller financing has always had a number of problems.
How available is seller financing?
If you require seller or owner financing to buy a home, your options may be limited. A quick search on a national real estate site found that in areas with about 2,500 listings, the keywords “owner financing” or “seller financing” only yielded about 40 of those listings. And another 30-ish listing turned up under a search for lease options.
So if you insist on seller financing, over 97 percent of all listings are off the table for you.
Why the shortage of seller financing?
Owners typically need cash from the sale to buy a replacement home. According to ATTOM Data Solutions, only about a third of Americans own their homes free and clear. So the other two-thirds have to pay off their mortgage lender when they sell. And many sellers, even those with 100 percent equity, need the proceeds of the sale to buy their next home.
Seller financing may require a larger down payment than mortgage programs, especially those backed by the government that requires less than 5 percent down or even nothing down.
Finally, seller financing ties the owner and the buyer together. That may not be a happy relationship if the purchaser makes payments late or not at all. The seller’s recourse can be foreclosure. However, this is an expensive, difficult process that can take months to complete. Meanwhile, the seller gets no income from the property.
Seller financing and buyers’ markets
Why don’t we see more seller financing? In a lot of ways, owner carry-backs seem like a logical mortgage option.
According to the National Association of Realtors (NAR), the typical existing home sold for $253,600 in December. That’s a big number, plus December represented the 82nd straight month of year-over-year existing home gains.
Something else also happened. Existing home sales in December tanked. They were down 6.4 percent from November and 10.3 percent for the year.
What these numbers tell us is that with higher prices, ownership is not possible for many potential buyers. This reality also means that despite general trends, home prices may stall or even decline. The percent of homes selling above asking price has fallen and prices have actually gone down in several metro areas.
“Home prices are still rising, but more slowly than in recent months,” said David M. Blitzer, Managing Director and Chairman of the Index Committee at S&P Dow Jones Indices, in late January.
“The pace of price increases are being dampened by declining sales of existing homes and weaker affordability,” he said. “Sales peaked in November 2017 and drifted down through 2018. Affordability reflects higher prices and increased mortgage rates through much of last year.”
In an environment with slowing sales, one tactic from the past has been for sellers to offer their own financing. I’ll back your mortgage, they say to buyers if you’ll pay my price. However, sellers need to abide by some of the provisions of the Dodd-Frank Act passed in 2010.
Seller financing and Dodd-Frank
The 2010 Dodd-Frank had one purpose. To make mortgage lending safer for borrowers and investors. It put limits on many lender practices and charges, and it also required mortgage originators to meet certain standards.
Is an ordinary citizen carrying one mortgage legally an “originator?” Not usually. There are exceptions to the law that apply to private sellers.
A “mortgage originator,” according to Dodd-Frank, “means any person who, for direct or indirect compensation or gain, or in the expectation of direct or indirect compensation or gain; (i) takes a residential mortgage loan application; (ii) assists a consumer in obtaining or applying to obtain a residential mortgage loan; or (iii) offers or negotiates terms of a residential mortgage loan.”
How to buy a home with seller financing
Assuming that you can find a seller-financed home or convince a seller to finance it for you, there are a few rules.
Sellers who finance your home purchase are not legally “loan originators” if:
- They are natural persons, estates or trusts
- Sellers provide financing for only one buyer in a 12-month period
- They own the property backing the loan
- They did build or act as the contractor for the property
Because they don’t legally count as originators, sellers, unlike regular lenders, don’t even have to make sure that you can afford the loan (the Ability to Repay rule in Dodd-Frank). However, there are limits on the type of financing they can offer.
- The loan cannot create negative amortization
- The loan can have a balloon payment
- ARM (adjustable) loans are allowed, but there are strict restrictions on its terms
If your seller has financed more than one seller in the last 12 months, he or she may be able to finance you as private citizens, but the rules are tougher.
- Sellers can finance up to three properties in a 12 month period
- The loan cannot have a balloon payment
- The seller has to investigate your ability to repay the loan
There other rules and requirements for seller take-backs. Sellers will want an attorney to prepare both the sale agreement and the loan documents to assure they are in compliance with Dodd-Frank as well as state and local rules. What owners do not want is sale agreement forms or mortgage paperwork provided by a borrower.
Try a lender first
If you want the best choice and the most leverage in your house hunt, an all-cash or pre-approved mortgage is the way to go.
And for most sellers, financing their sale may not be worth the hassle and potential problems. There is, of course, a ready alternative to seller financing and its complexities. Let lenders take care of it.
Then the financing process is their problem and owners will get their money at closing. And if a buyer cannot get financing from commercial lenders, then maybe that’s not the person you want to finance anyway.