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Selling Real Estate

Seller Financing Alternatives

Most finance and real estate professionals discourage financing by the seller. If your mind is set, however, let's walk through some of your options.

IMPORTANT NOTE: Before going ahead with seller financing, consider reducing the purchase price of your home. This may result in the buyer being able to get regular lender financing. You'll get a lump sum right away rather than receiving monthly mortgage payments; and you avoid complications and headaches.

Avoiding Risk

Let's take a look at some of the less risky ways to assist with financing. If you must provide incentives in order to speed up the sale, we recommend you pursue these methods first.

Buying Down the Rate

Buying down the mortgage loan interest rate is an easy and relatively cheap way to avoid the risks involved with lending funds directly. Lenders charge up-front fees for reducing the interest rate on a mortgage loan over the life of that loan. Essentially, you're prepaying interest, similar to points. The cost is calculated as a percentage of the loan balance, so the smaller the down payment the buyer is making, the more this route will cost you.

SUGGESTION: A buy-down works essentially the same as a reduction in purchase price from your perspective. From the buyer's perspective, however, it is more powerful since a lower mortgage interest rate allows the buyer to qualify for a larger mortgage loan which makes them better able to afford your home. Because of the calculation methods used by lenders, the effect of lowering the interest rate is greater than if you had simply reduced the purchase price of your home.

Assisting With Payments

Although assisting the buyer with mortgage payments is nothing more than a reduction in purchase price, there is a very strong psychological appeal. Buyers are attracted to the idea that they're living on someone else's tab for a few months.

SUGGESTION: See if you can put the amount you've agreed upon into an escrow account directly with their lender with the stipulation that the appropriate amount be withdrawn each month to cover their payment. This eliminates some of the paperwork and headaches for you.

Sharing in the Closing Costs

Since closing costs for a buyer can be quite expensive, you may offer to assist with some of the payments that are due on contract signing day. Most commonly, this assistance will be in the form of you paying some or all of the buyer's points. You may assist with any of the other costs. Once again, the end result is a reduction in what you walk away with; but for the buyer, it may appear as though they cut a better deal by getting you to pay some of their expenses.

IMPORTANT NOTE: Some lenders place limits on how much of the closing cost a seller may assume. Make sure you are not running afoul of these rules when you make your deal.

Assumable Mortgages

This is potentially a very attractive route for a would-be buyer. This is especially true if you have a mortgage with a rate lower than those currently available in today's market. The buyer who assumes your mortgage may still need to secure outside financing for the difference between the selling price and the amount remaining on the mortgage they are assuming. This is your equity.

The problem with this approach is that assumable loans are very hard to find. If you have one, and the buyer makes a sizable down payment, this may be an appropriate option if you are anxious to sell.

IMPORTANT NOTE: Determine exactly what your obligations are should your buyer default on the assumed mortgage. In some cases, you may remain liable if the buyer defaults. This could result in a damaged credit rating for years to come. Even if the buyer must qualify before assuming the note, make sure you get your rights and obligations spelled out so you know where you stand.

Becoming a Lender

In this situation, you lend the buyer the money needed to close the deal rather than the bank. This is risky business so you should be compensated for your risk. Consider offering an interest rate one to two points above the prevailing current rate. Keep the loan to a ten-year maximum; anywhere from three to eight years is common.

IMPORTANT NOTE: Since each deal is negotiated individually, any seller financing arrangement you enter into will have no standard mortgage documentation. No matter what form your financing arrangement ultimately takes, you will want to protect your interests and use an attorney skilled in this area. Do not rely on your real estate agent to handle this for you.

Seller Financing Tips

Before assisting in the financing of your home sale, consider the following points:

  • Be sure you get a sizable down payment of 20% or more. The more cash the buyer has invested, the more committed they are to making future payments.
  • Carefully evaluate the buyer's credit history before making any commitments.
  • Make sure the sales contract allows time for a careful review of the credit report. Add language that allows for cancellation if the credit report doesn't check out.
  • Get a financial statement from the buyer.
  • Record a lien on the property and add a due on sale clause in the deed. This guarantees you get paid if the home is subsequently sold by the buyer.
  • Make sure you get an attorney involved in all proceedings. All contingencies should be spelled out in writing. Get specific—don't leave any gray areas.
  • Make property insurance on the property mandatory. Insure at least the value of the loan and collect the insurance premiums along with the buyer's monthly payments.
  • Avoid being patient with late payments. Insist that late payment penalties be included in your note.
  • Be aware that foreclosure proceedings, if they are needed, are long and tedious.

IMPORTANT NOTE: The IRS requires that mortgage interest payments be reported. As a recipient of mortgage interest, you will be responsible for the year-end issuance to the buyer of Form 1098 to the borrower if the IRS considers you to be in the trade or business of lending money. While it is unlikely this will apply to you, consult your tax professional to be safe.

Creative Financing Alternatives

In a very dismal market, a seller may need to devise a unique and innovative strategy to attract scarce buyers. For most people, this route is risky and you should be guided by a real estate attorney with experience handling these transactions.

Lease-Option

Under this arrangement, you lease your home to the buyer for an agreed-upon monthly rent. This provides the cash you need to continue paying your existing mortgage. You then offer the buyer an option to buy the home for a set price within a set period (this is typically two years). In addition to the monthly rent payment, you charge a set monthly amount for keeping the option open as well as a one-time charge of 2% to 6% of the purchase price payable at the beginning of your contract. If the option to buy is exercised, you credit these amounts to the purchase price. If the option is not exercised, you walk away with the money as compensation for taking the home off the market for the period of the agreement.

SUGGESTION: The up-front one time charge and the subsequent monthly payments provide a powerful incentive for the potential buyer to exercise their option to buy. Make both as high as you can since it essentially acts as a prepayment on the sale for you.

IMPORTANT NOTE: If property values are dropping in your area, your best bet might be to avoid the lease-option route and sell now. If the agreed upon buy price becomes too high relative to the new market values, the option won't be exercised. The money you received up-front as well as the monthly payments are yours to keep, but they may amount to less than your home's drop in value leaving you with the short end of the stick.

IMPORTANT NOTE: Your current mortgage may treat the lease-option arrangement as a sale of the property. If so, the document contains a due on sale clause making the balance of your mortgage immediately payable in full. Always check with your lender before you enter into this type of arrangement.

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