Seller financing has been a hot issue in recent real estate news due to the changes in regulations, specifically in the Dodd-Frank Act. Here’s what you need to know to incorporate this method into your business strategy and be the best advocate for your clients.
Know What You’re Talking About
Stated simply, seller financing is where the seller holds the mortgage for the buyer instead of a traditional lender such as a bank.
Numerous websites can provide more information, but two sets of rules are always important, according to the National Association of REALTORS®. In both cases, sellers cannot provide seller financing more than three times a year without a loan originator license and would not qualify for regulatory exemptions if they had constructed the residence on the property. Also, there are rules in place to prevent predatory lending, wherein the seller ensures that the buyer can repay the loan. It does not require documentation but it wouldn’t be a bad idea to ask the buyer to furnish bank stubs, W-2s, tax returns, or other financial information.
Stricter rules apply to a seller who is a person, a trust, a corporation, LLC, or other business entity that sells more than one but no more than three houses per year. Under these conditions, the loan must be fully amortizing.
The more lenient rules — under which the loan can be fully amortizing or it can be a balloon mortgage — apply to a seller who is a person or trust and sells only one house per year using seller financing. Under these rules, the loan can have a fixed interest rate or an adjustable interest rate (under the stricter rules, the rate cannot adjust until after five or more years). In either case, there are more rules to follow when the loan has an adjustable rate, so be sure to do the additional research if your client is going that route.
Seller financing is just one of the many methods known as creative financing. Other methods include assumptions, wraps, lease options, and private seconds. Read up on these topics as much as you can. I suggest reading Building Wealth One House at a Time by John Schaub if you are interested in learning more about creative financing. John is a full-time investor. He buys, sells, and manages all of his properties and teaches others to do the same. If a seller thinks that this type of financing is too risky, Schaub assures, “Landlords are used to letting someone move into their house after paying only one or two months’ rent and a security deposit. If the rent and security deposit on a house totals $3,500, then letting someone move in with a $5,000 down payment is less risky than renting them the property.”
This all may seem like boring legalese, but it’s important for you to know. Your client may not qualify for a loan, throwing the deal into jeopardy. Or they may have no trouble getting approved for their first loan, but be unable to get a second loan. You need to stay up-to-date on this topic in order to be your clients’ trusted adviser.
Know Who It Will Benefit and How
What types of sellers can offer this type of financing? Sellers who own their homes free and clear or who have a small mortgage that can be paid off with the down payment. According to the U.S. Census’ 2009–2013 5-Year American Community Survey, around one-third of owner-occupied housing units in the United States do not have a mortgage.
How does a seller benefit from this type of financing? More financing options attract more buyers. Furthermore the seller will only be taxed on the monthly payments per year and not on the entire purchase price at once. For example if the free-and-clear house sells for $100,000 cash or via a traditional loan, the seller pays taxes on $100,000. If he finances the house and receives $750 per month, for example, he pays taxes on $9,000 ($750 x 12) per year.
It’s also important to understand the types of buyers who benefit from seller financing. Generally, they fall into these two categories:
- The buyer who can’t get traditional financing. Most banks are not flexible with loan terms. With seller financing the buyer can negotiate the terms of the mortgage face-to-face with the seller, with you by their side. And typically there are fewer closing costs without a traditional lender.
- The buyer who does not want traditional financing, such as an investor. Rather than a standard down payment required by banks, investors can finance the entire purchase or offer a lower down payment along with something else for the seller, such as a higher monthly payment, a boat, hockey tickets, golf clubs, or other perks, or they can finance the down payment.
Understand How Seller Financing Can Work for You
As an agent, you can help more buyers and sellers by having this knowledge, but it’s important to understand your role. Generally, you’ll be paid for your work in the same way you’d be paid at a traditionally funded closing. The seller can use the buyer’s down payment to pay your commission. Or you can opt to be paid monthly, over time. Choose whichever way you are most comfortable with, but make sure to get it in writing.
You can use this knowledge to tap into a new market. Create a niche. Be known in your office as the agent who specializes in creative financing. Do some research in your farm area. Send mailers to households that own their property free and clear, stating that you can sell their home quickly with seller financing. However, it is very important that you do not negotiate the terms of financing.
Be sure you know the rules and regulations, especially the Dodd-Frank Act. Talk to a CPA so you know the tax implications. Interview title companies or attorneys that specialize in this type of closing. If you are comfortable with this, your client will be comfortable as well. Educate your clients and close more deals with seller financing this year.