Seller Financing: What to know About This Mortgage Alternative
Whether you are buying or selling a home, most transactions will have a lender involved in financing the real estate transaction. But what if that lender is not a financial institution, such as a bank or credit union?
There is, in fact, an alternative to working with a traditional mortgage lender. It’s called seller financing, and it can offer benefits to both buyers and sellers alike. However, there are also potential disadvantages that you should be aware of before entering into this type of agreement.
Let’s take a closer look at seller financing, also known as a purchase-money mortgage or owner financing, to help you decide if the practice is right for your situation.
What is seller financing and how does it work?
In simple terms, seller financing describes a real estate transaction in which the property owner also serves as the mortgage lender. A seller financed mortgage sidesteps the need for a traditional mortgage lender, since the buyer makes payments to the seller (typically in installments) instead of to a financial institution.
While it functions much like a traditional mortgage loan, a seller financing agreement allows the home seller to own and oversee the debt, including providing financing and handling the mortgage process. The seller extends enough credit to the buyer to cover the purchase price of the home, minus any down payment.
A promissory note and a document called the Mortgage containing the terms of the loan is signed by the buyer, and the mortgage document is recorded with the local public records authority. The original promissory note is held by the seller. The buyer pays back the loan, typically with interest, over time. These loans can be short-term, and may include a balloon payment, meaning a lump sum is paid during or at the end of the term.
What are the types of seller financing arrangements?
There are several types of seller financing that may be used between a buyer and a seller, including:
- Land contracts: A land contract in Michigan grants buyers an equitable title to gain immediate control over the property. The legal title or vesting title remains with the seller until the fulfilment of the land contract. The land contract is an agreement to purchase a piece of real estate in which thebuyer borrows equity from the real estate owner, rather than borrowing money from a bank, credit union or financial institution. The buyer will make a down payment and then continue with monthly payments through the contract date. Typically, a balloon payment (or lump sum) follows the repayment period and will be due at the end. Once the purchase price is paid in full, the deed will be given to the buyer, and the contract with be complete
- Assumable mortgage: A type of home financing in which buyers are given the opportunity to purchase a home by assuming responsibility for and taking over the seller’s current mortgage, especially if that loan has a lower interest rate.
- Lease purchase: Also known as a rent-to-own contract, a form of agreement under which renters pay sellers an option fee at an agreed-upon purchase price that gives the renter the exclusive lease option to purchase the property at a later date.
- Holding mortgage: An agreement whereby a homeowner agrees to serve as a lender for the home buyer and provides a loan for the purchase, which the buyer repays via monthly payments to the seller. The seller holds the property’s title until full loan repayment has been made by the buyer.
What is a land contract and how does it differ from a mortgage?
As defined above, a land contract is a type of specialty home financing in which a seller agrees to finance a property for a buyer in exchange for the buyer meeting the terms agreed upon in the contract. In a traditional land contract, the seller keeps the legal title to the property until it’s fully paid off, while the buyer builds up equity in the property.
Additionally, a wrap-around land contract allows a seller to keep paying on their existing mortgage, earning the difference between their mortgage payment and what they receive monthly from the buyer. Although in this type of situation the seller’s lender has to agree to the contract.
Installment payments are typically due at periodic intervals as agreed between the buyer and seller in a land contract. At the end of the term, there may or may not be a balloon payment. Land contracts have always been a viable option for those seeking an alternative to a traditional mortgage.
What does a land contract cover?
There are several components to a properly executed land contract, including:
- Sales Price: This covers how much the property is being sold for. As the buyer, your obligations under the land contract are over once you pay off this amount of principal, and you’ll get the legal title at the time of payoff.
- Down Payment Amount: This is due at closing and may be designated as a percentage or a flat amount in your contract.
- Interest Rate: This is defined in the contract, as well as the terms around whether the rate can ever change. The timing and conditions under which the interest rate could change should also be defined.
- Payment Amount: This should be spelled out, along with how often it needs to be made. The contract may have specific due dates and late fees, and will also include whether there’s any balloon payment due at the end of the loan term. Any penalty for paying off the loan early should also be disclosed.
- Responsibility of the Parties: This includes clauses in the contract stating the responsibilities of the parties to each other, and the buyer agrees to make the land contract payment. There should be clear language regarding the consequences of the buyer falling behind on their payments. And, if any missed payments are allowed, the timeline for paying them back should be included. Finally, the contract should state under what conditions the buyer might become delinquent to the point that the seller takes the property back.
- Title Settlement: This includes language that says the buyer gets the legal title once all terms of the loan are satisfied. If it’s a wrap-around mortgage, it’s advisable to have written in that the seller will make payments on the underlying existing mortgage. If the seller doesn’t make the payments and the buyer loses the house as a result, they have the option of legal action. It’s also a good idea to add a clause that requires the seller to keep careful track of the buyer’s history of payments.
Can you convert a land contract into a traditional mortgage?
Buyers who are able to improve their credit and meet other qualifying standards can take advantage of better terms and/or pay off a balloon payment by converting their land contract to a traditional mortgage, they will do this as a refinance type loan with a lender of their choice. Lenders may need to verify the value of the property, and buyers will be subject to standard income, asset and credit checks.
A copy of the fully executed land contract will also be required. The land contract payoff balance will be necessary in order to determine the loan amount, and any underlying mortgage in a wrap-around contract would need to be paid off so that the title is clear. The seller will need to give the final deed to the buyer at closing when they receive their payoff. It’s also important for the buyer to provide the new lender with their payment history on the land contract so they can verify their qualifications.
Vanguard Title can help you weigh your options
Seller financing can be an attractive option to help homebuyers qualify for additional mortgage opportunities, reduce associated red tape and improve profit margins on lending. However, this type of agreement isn’t without potential disadvantages. It’s always a good idea to do plenty of research and work with a qualified real estate agent and/or attorney prior to entering into any home financing agreement.
Whether you’d like to learn more about seller financing or you’re seeking a traditional mortgage lender, Vanguard Title is here to help. Our staff of skilled title and closing professionals can keep you informed and connect you with helpful resources throughout your real estate transaction.