Sellers have the option of financing the buyer’s purchase of the home using the equity they already have on the property. Sellers can choose to finance the entire mortgage or a portion of it for the buyer. Consult with your attorney before committing to a private mortgage.
Carrying Back a Second Mortgage
In this financing option the seller loans the buyer a portion of their equity on the home. The buyer finance the majority of the loan through a typical mortgage and finances the remaining portion in collaboration with the seller. The buyer will usually have a slightly higher interest rate on the loan from the seller.
Considerations for Seller Financing
The Purchase Price
The seller and the buyer agree upon the purchase price. The seller is cognizant that the buyer wants them to finance the transaction. The seller may be reluctant to lower the price of the home if they are financing the deal.
Depending on the size of the down payment the buyer will be more or less committed to the mortgage agreement. The larger the down payment the stronger their desire to protect the home. The buyer will have a willingness and motivation to maintain or renovate the property and make tax and insurance payments.
The interest rate should at the very least match current interest rates offered by traditional mortgage lenders however there may be an additional percentage point added to compensate for servicing the loan.
Buyers Credit and Income
The seller will want to know if the buyer is going to pay their debts and may wish to review their credit report which will give a more comprehensive view of their financial history. Any late payments or loan defaults will be of concern and if the buyer has a less than perfect credit score the seller may choose to not finance the loan or require a larger down payment. The seller may also want to review the buyer’s source of income to see if they will be capable of making the monthly mortgage payment. The seller will also want to consider any additional sources of income in the event the buyer enters a financial hardship from job loss, medical bills, etc.
Amortization is the duration of time in which the loan will be repaid. The longer the amortization is the longer the seller will have the risk that the buyer will default.
The full principal balance of the loan will be due on a certain date typically in 5-10 years. The seller/lender will have a profitable short-term investment knowing the mortgage loan will be paid in full in a relatively short period of time. After the 5-10 year period the buyer will typically be more capable of securing a traditional source of financing. The buyers equity in the property viewed in conjunction with a history of on-time mortgage payments will assist the buyer in securing a loan to pay the balloon payment.
Tax & Insurance Escrow
Lenders will most of the time require borrowers to pay 1/12 of their annual taxes and insurance costs for an escrow payment that is due as part of each monthly mortgage payment. The lender will use this money to pay the borrowers annual tax and insurance payments. This will be inconvenient and time-consuming for the seller-financer but the benefit is they avoid the buyer making the mortgage payments but not tax and insurance payments.
Lender’s Title Insurance
The lender’s title insurance policy protects the property from having the lien be defeated by a prior lien or interest on the property that could potentially wipe out the security. Marriage, divorce, death, forgery, judgments for money damages, failure to pay state or federal taxes, and more can all affect the rights of the seller-financer. The seller-financer should include the price of the lender’s title insurance as a portion of the closing cost.
Closing the Sale
The buyer and the seller are both responsible for the typical closing costs but the seller-financer may also have the buyer pay the costs resulting from the mortgage financing. Part of this cost can be the attorney fees for the mortgage note.