Friday, March 27, 2009

Seller Financing: Seller's Advantage

It used to be that financing was so easy, seller financing as a concept fell to extremely distressed properties and the shadows of usury. But no more.

Nowadays, the slightest credit blip could prevent someone from receiving an affordable, reasonable loan by a bank or other mortgage lender. In this case buyers and sellers may turn to some type of seller financing in order to buy a home. While this post is in the context of homestead purchases, seller financing is a well-known concept in entrepreneurial finance, and its distant cousins are all over typical large corporate finance.

Anyway, in a home seller financing arrangement, the seller would agree to sell her or his property to a buyer of the seller's choosing, but not accept payment at closing. Instead, the seller issues a debt instrument in the amount of the sale to the buyer / "borrower." Done correctly, this can create a first lien position for the seller just like any other mortgage lender, with the sole right to foreclose on the property as collateral.

The debt instrument is actually a mortgage issued by the seller to the borrower, or wherein the buyer is the mortgagor and the seller is the mortgagee. The seller in most every case will not be able to pass on or sell that mortgage to third parties easily, but it can be an important source of income if the seller does not need the lump sum at closing - similar to an annuity.

The seller-financed mortgage will contain all the terms of a regular mortgage as the parties agree, and it should be drafted by an attorney in the state of the transaction. Terms can include required down payment, interest rate, payment schedule, amortization schedule, term (15, 20, 30 years, etc.), and perhaps most importantly, the default terms and foreclosure procedures in line with state law. In "Deed of Trust" states like Florida and Texas, the seller will hold the Deed of Trust, which gives the seller the right to foreclose on a loan in default. In such a case where the seller believes the buyer to be in default, the seller most likely would hire a foreclosure attorney to handle the foreclosure.

But here's where things get very interesting: in the event of a foreclosure in most DT states including Texas, the foreclosing lien-holder (in this case, the seller) gets to reclaim the property and re-sell it while keeping past payments including the down payment of the defaulting borrower. Whereas foreclosures are mostly a quagmire for large financial institutions, the opportunity to charge an attractive interest rate to someone who can't or doesn't want to get a private loan along with the opportunity to reclaim the property to re-sell it in the event of default - it can create a substantial financial advantage for the seller and a fair opportunity for a buyer.

Sellers can do short-term loans to help a buyer through a rough credit patch - the 30 year mortgage is not the only arrangement. A seller could offer a buyer 2 to 5 year financing with a 30-year amortization schedule (payments based on a 30-year loan) but requiring a balloon payment of the balance in 2 to 5 years or 7 or 10 or whatever. Most buyers will not have the cash for a balloon payment at that time, but the implication is that the buyer will have to refinance in order to pay off the balance to the seller. Notice, if the buyer does not successfully refinance, then they may trigger default / foreclosure terms and lose all their past payments and equity to the seller/lender.

Sellers with an existing mortgage most always cannot do this because traditional mortgages usually have terms that do not allow it. But even for sellers who do not have their property paid in full, they may be able to tap other funds to pay off their mortgage so they can take advantage of a seller-financing opportunity.

This post is meant merely as a framework for an idea and is not financial or legal advice or legal opinion. Any seller considering this opportunity in today's market should consult real estate brokers, financial advisers, accountants, and most importantly, a trusted real estate attorney.

Frankly I am surprised we don't see more seller financing in this market.