Unlike a few years ago, most banks now require large down-payments, even for good credit buyers. The problem is that many good credit buyers in today's market are short on cash. One solution to this problem is for the seller to offer financing to the buyer. In fact, it is anticipated that soon 1 in 10 transactions may require seller financing.
Selling financing is a time-tested solution to tight credit markets, and easy to understand: some or all of the purchase price is financed by the seller in the form of a promissory note. Deciding whether to owner finance, however, is not so easy. Sellers have many questions - How do I structure, underwrite, and document it? What happens if the buyer defaults? What are the tax implications? If you are going to attempt this type of deal, first make sure you have 1) a good real estate calculator; and 2) an experienced real estate attorney and tax advisor. Then follow these Steps:
- Step 1: Purchase Price - You and buyer should agree to a purchase price;
- Step 2: Financed Amount - Determine the amount you are willing to finance. Consider a) how much you owe on your current mortgage; b) the loan amount buyer has been approved for; c) the maximum amount the buyer's lender will permit in seller financing.
- Step 3: Terms of Loan - Determine the interest rate, duration of loan, and amortization. There are many factors to consider. Interest only payments? Balloon? High default interest rates?
- Step 4: Underwriting - This is more art than science. Consider the "4-C's" of underwriting: a) Credit; b) Capacity to repay loan; c) Collateral (value of house); d) Character of buyer. Unlike a big bank, you will be able to create your own approval standards.
- Step 5: Documentation - Do NOT try to do this yourself. Get an experienced real estate attorney to draft the necessary documentation.
- Step 6: Closing - Go to settlement on the property as you normally would. Have your newly created mortgage recorded by the title company in the proper County land records. You can even get title insurance to protect your interest in the property.
But before you jump into owner financing, consider the following:
Underwriting: This may be difficult for a novice. If you don't know the buyer, how do you determine his character and whether he will pay you back? One tool is the credit report. Analyze any derogatory marks and dig deep into why these things may have occurred. Maybe a spouse died or someone lost a job. Remember - you have the underwriting flexibility a bank doesn't, so apply common sense.
Existing Loans: If you finance the entire purchase price of your home and you have an existing mortgage on the property, you will have to maintain that mortgage payment even after you sell your home. This is called a "wrap." However, you may be violating the lender's "due-on-sale" clause contained in your mortgage documents. This shouldn't be fatal to your deal, but it must be addressed.
Taxes: If this your primary residence or an investment property? You must address any capital gains/tax liability issues you may have. For instance, if you sell an investment property and finance the entire amount, you could still owe taxes at the end of the year - even if you didn't get any money at closing!
Default: Even with the best borrowers there is always a risk that payments will not be made as promised. If that happens, you will have to consider multiple options - from foreclosure to loan modification to a "deed in lieu." Your local real estate attorney can properly address these issues.
Note Selling: The note-purchasing business is bustling. Many sellers trade in long-term note payments for immediate cash. You could structure a long term note with the buyer and then sell it at a discount, while still extracting all the cash you originally wanted.
Seller financing will undoubtedly be some of the "grease" that keeps the wheels of real estate turning until the credit markets return, but be sure to have the correct professionals assisting you. This will insure that the deal is fairly structured and that there is a legally binding contract between all parties.
Jeffrey Shiller is a Maryland attorney specializing in real estate. He is a principal of The Law Office of Jeffrey P. Shiller, PA & Hard Money Bankers, LLC. His services include settlements, loan document production, and structuring creative real estate transactions and hard money deals. He can be reached at jshiller@crowntitle.com or http://www.viprealestatelaw.com
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