Selling Your House For Dummies
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You may want to take on the role of banker to lend money to the buyer of your house. And what would possibly motivate you to do such a thing? Usually one of the following reasons:
  • Desperation: Some houses are difficult to sell because of major warts, and some won’t sell because they’re overpriced.
  • A high interest rate on your money: You have dollar signs in your eyes. You can earn a higher rate of interest lending money to the buyer of your house than you can investing through bank accounts and most bonds.
If your local real estate market is slow or you’re having difficulty selling your property, you may sweeten the appeal of your house by offering to be the mortgage lender. Prospective buyers of your property may realize that they can save thousands of dollars in loan application fees and points (upfront interest). After all, you’re not a big bank with costly branches to operate and countless personnel to pay.

By offering seller financing, you broaden the pool of potential buyers for your house. Traditional mortgage lenders are subject to many rules and regulations that force them to deny quite a number of mortgage applications. But making loans to borrowers rejected by banks can be risky business.

You absolutely, positively must thoroughly review a prospective borrower’s creditworthiness before you agree to lend him money as a condition of selling him your house.

In addition to helping sell a house, some sellers are motivated to play banker and lend money to the buyer of their property because the mortgage usually carries an attractive interest rate, at least when compared to the typical returns on conservative investments, such as bank savings accounts (currently 1 to 2 percent) or CDs and Treasury bonds (currently around 2 to 3 percent).

If you have money to invest but investing in stocks terrifies you, lending money to the buyer of your house may interest you. You may be able to earn 7+ percent in interest by lending your money to a borrower.

Agreeing to offer a mortgage to the buyer of your house can clearly be advantageous; the loan may help sell your house faster and at a higher price and, at the same time, provide a better return on your investment dollars. However, nothing that sounds this good ever comes without some real risks.

If you lend your money to someone who falls on difficult financial times or simply chooses to stop making mortgage payments, you can lose money, perhaps even a great deal of money. And you may have to take legal action and foreclose if the buyer defaults on the loan. And if all that isn’t bad enough, you’ll again be the owner of a house that you thought you’d sold, with all the associated expenses of home ownership, including higher loan payments for the buyer’s new first mortgage and, most likely, a higher property tax bill. Foreclosed homes also tend to deteriorate under the care of the prior owners, so you can also expect fix-up costs.

Important considerations for seller financing

To consider making a loan against the house that you’re selling, you should be able to answer yes to all of the following questions:
  • Will you be able to purchase the next home you desire without the cash you’re lending to the buyer of your current house? This issue keeps most sellers out of the financing business. If you need all the cash you have as a down payment to qualify for the mortgage on your next home, seller financing is out of the question. And, if you can lend some of your money to the buyer of your house, don’t make the loan if you then need to borrow more yourself for your next home purchase. Even if you can charge the buyer of your current house 2 percent or more in interest on the money you lend than you’ll pay for the money you’re borrowing to buy your next home, such an arrangement generally isn’t worth the hassle and financial pitfalls.
  • Do you desire income-oriented investments? Understand that mortgages are a type of bond. When you invest in a bond, your return comes from interest if you hold the bond to maturity. Unlike investing in stocks, real estate, or a small business, you have no potential for making money from appreciation when investing in bonds held to maturity. If you’re looking for growth as well as income, seller financing isn’t for you.
  • Are you in a low enough tax bracket to benefit from the taxable interest income on the mortgage loan? If you’re in the federal 28 percent or higher tax bracket, consider investing in tax-free bonds, such as municipal bonds, and not mortgages, the interest on which is fully taxable. The reason: The interest income from municipal bonds is free of federal taxation and sometimes state income taxation. By contrast, the interest income from a mortgage is taxable as ordinary income at the federal and state levels.
  • Are you willing to do the necessary and time-consuming homework to determine the creditworthiness of a borrower? As we discuss in the next section, unless you secure a large down payment (25 percent or more of the value of the property) from the buyer of your house, you need to be darn sure that the borrower can pay you back. If you’re looking for a simple, non-time-consuming investment, look elsewhere. Try mutual funds and exchange-traded funds.
  • Can you weather a default? Even if you do all the homework we suggest in this chapter before agreeing to lend money, the buyer/borrower still can default on you just as he can on a banker. Bad and unforeseen events can happen to borrowers. Accept this reality. Ask yourself if you can financially tolerate going without the borrower’s payments for many months during the costly and time-consuming process of foreclosure.

About This Article

This article is from the book:

About the book authors:

Eric Tyson, MBA, is the author of Investing For Dummies, Personal Finance For Dummies, and Investing in Your 20s and 30s For Dummies. Ray Brown, a real estate professional for more than 40 years, is the best-selling co-author of Home Buying For Dummies.

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