Seller financing has certain advantages


January 02, 1994|By Dian Hymer

What is seller financing?

Seller financing occurs when sellers loan money to buyers as a part of a property sale. The property being sold is usually used as security for the loan.

The benefit to a buyer is that sellers usually don't charge loan origination fees, called points. (One point is equal to 1 percent of the loan amount).

Buyers with only a 10 percent down payment will find an additional benefit if they can find a seller who will provide a loan for 10 percent of the purchase. This would permit the buyer to get an 80 percent loan, rather than a 90 percent loan, from a conventional lender.

Eighty percent conventional financing is less expensive than 90 percent financing in terms of the points charged, the interest rate on the loan or both. Also, most 90 percent loans require PMI (Private Mortgage Insurance to protect the lender if the buyer defaults). This is an additional charge that is bypassed if the buyer only needs to borrow 80 percent or less of the purchase price from a lender.

A buyer might find it easier to qualify for financing with a seller than with a conventional lender, but this won't always be the case. Most sellers will want to scrutinize a buyer's financial status, including a credit report, just as a lender would. A purchase contract that provides for seller financing will usually give the seller the right to approve or disapprove the buyer for the loan.

There are disadvantages to seller financing. In this market of extremely low interest rates, you'll probably find conventional financing available at interest rates lower than most sellers will be willing to accept. Another disadvantage is that most seller-carry loans have shorter due dates -- the deadline for repaying the entire loan -- than conventional loans. Few sellers will be willing or able to carry a loan for 15 or 30 years. But if the buyer is getting a new first loan from a conventional lender, the lender will require that the seller carry the second loan for at least 5 years.

Most conventional loans are fully amortized, which means they are paid off in full over the term of the loan. Seller-carry loans, however, are rarely fully amortized (some have interest-only payments) which means that there could be a large "balloon" payment due at the end of the loan. The property may have to be sold or refinanced at that time in order to repay the sellers.

FIRST-TIME TIP: The obvious candidates for owner financing are seniors who own their homes free and clear of any loans. If they're selling in order to trade down to a retirement home, there may even be a tax incentive for them to carry financing. Seller-carry loans can be treated as installment sales for tax purposes, which allows the seller to spread tax on the gain over the term of the seller-carry loan. Carrying a loan at a reasonable interest rate might also provide attractive income to a seller who's income is fixed. In this case, the seller might not want to be paid off early and may request that the loan include a prepayment penalty. This could become an item of negotiation.

THE CLOSING: To make sure that you're not paying an overinflated price in exchange for seller financing, make your purchase offer contingent upon the house appraising for the purchase price. If you're applying for a new conventional first loan, and the seller's carrying a second, the lender or loan broker will order an appraisal. If the seller is carrying a first loan, you'll have to order an appraisal yourself.

Dian Hymer's column is syndicated through Inman News Features. Send questions and comments care of Inman News Features, 5335 College Ave., No. 25, Oakland, Calif. 94618.

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