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In addition to borrowing through traditional mortgage lenders and brokers, you may find some house sellers offering to lend you money if you agree to buy their home. Some long-term homeowners no longer have mortgages on their property. These fortunate folks often offer attractive financing to qualified buyers either to get a higher purchase price or to structure their transaction as an installment sale (a plan that spreads out proceed payments over future years) for preferable tax treatment by the IRS.
 | Other sellers may believe that the loan will help sell the house faster and provide a better return on their investment dollars. And therein lies the reason you should be highly cautious about seller financing. Generally, sellers offering houses for sale with financing have a tendency to be selling problematic houses with major flaws. Another possibility is that the property may be priced far above its fair market value. Alternatively, however, the sellers could be offering financing because the local real estate market is sluggish or because they can't think of better ways to invest the proceeds of sale. |
Considering/soliciting seller financing
Some house sellers who aren't offering to provide financing may consider it; you won't know until you ask.
Consider seller financing under the following conditions:
- The property does not have fatal flaws. Avoid buying a house with incurable defects.
- You can buy the property at its fair market value or less. Seller financing is often offered on properties that aren't selling. Property that's gathering cobwebs is generally overpriced. Saving 1 percent on a seller-financed loan won't mean much if you grossly overpay for the house.
- The cost of the seller-financed loan is as low or lower than you can get through a traditional mortgage lender. Why borrow from the seller if it won't save you money? Of course, if you have credit problems that make borrowing from traditional lenders prohibitively costly or impossible, that's another good reason to borrow from a seller.
Overcoming borrower problems
You may be tempted to consider borrowing from a seller because of problems with your credit or financial situation. Smart house sellers will pull a copy of your credit report. If they discover blemishes, they won't grant you a loan or will charge you a much higher interest rate. Be sure the warts on your report are correct. Credit reporting agencies and creditors who report information to the agencies have been known to make mistakes.
 | Provide a written and detailed explanation of any problems on your credit report at the time you apply to the sellers for a loan if you know that they're going to pull a credit report. Another way to address a seller's concerns is to get a cosigner, such as a relative, for the loan. |
If your income is low, you could try to accumulate a larger down payment to placate the lender or get a relative with sufficient income to cosign the loan.
Negotiating loan terms
Call several local lenders to find out the rate they're charging for the size and type of loan that you're contemplating (for example, 15- or 30-year, fixed-rate mortgage; first or second mortgage; or owner-occupied or rental property). Be sure to ask about all the fees — application, appraisal, credit report, points, and so on.
If you're in good financial health and can qualify easily to borrow from a traditional lender, you should expect better terms than the traditional mortgage lenders are offering you. How much better? The terms depend in large part upon how good at negotiating you are! Aim for at least a 1-percent reduction in the ongoing interest rate as well as on the up-front fees. For example, if traditional lenders are charging 8 percent plus two points (percent) up-front, aim to pay no more than 7 percent with one point.
Deciding whether to provide seller-financing
When it's time for you to sell your house, offering seller financing may broaden the pool of potential buyers for your property. Traditional mortgage lenders are subject to many rules and regulations that force them to deny some mortgage applications. However, making loans to borrowers rejected by banks can be risky business.
| To even consider making a loan against the house you are selling, all of the following conditions should apply to your situation: |
- Without the cash you're lending to the buyer, you should still be financially able to purchase the next home or property you desire. Most house sellers need all the cash from the sale of their current property to be able to buy their next one.
- You're willing to do the necessary work to assess the creditworthiness of a borrower. A smart mortgage lender would do the same before risking his money on a loan, so why wouldn't you?
- If the borrower defaults, you're in a financial position where you could afford to lose all this money. If the borrower does stop making monthly payments to you, you may have to initiate the costly process of foreclosure.
- You desire income-oriented investments and are in a low tax bracket. The interest income on a mortgage loan is taxable, so if you are in a higher tax bracket and you want interest income, you're probably better off investing in tax-free municipal bonds.
If all these conditions apply, then and only then should you consider extending a financing offer to a prospective buyer of your house. If you're going to do that, you should then do what every smart mortgage lender would do: Thoroughly review a prospective borrower's creditworthiness.
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