You've worked hard to pay off your home. But the time has come to sell.
Whether you're upgrading, downsizing, or moving to a new state – you're in the financial position to “act as the bank” for the new buyers.
Holding a mortgage note, also known as seller-financing, owner-financing, or private mortgage, is an alternative investment option.
It's one way for homeowners or landowners interested in selling their real property to diversify their investments and streams of income.
What Does Holding a Mortgage Note Mean?
Holding a mortgage refers to an agreement by the current owner to extend credit to a buyer purchasing their home, land, or other real property.
The buyer makes an agreed-upon down payment and pays monthly loan payments directly to the seller instead of a bank.
The financing arrangement usually includes a promissory note regarding the repayment and terms of the loan.
The note includes information such as:
- interest rate
- loan period
- balloon payments due
- prepayment rules
Penalties, fees for late payments, and default procedures are also usually included in the financing agreement.
A private mortgage is also generally written securing the property as collateral for the loan.
Note: It may be a requirement to record the mortgage with the local public records office.
It's strongly suggested to have a real estate attorney or other qualified professional complete the necessary paperwork for the financing.
A lawyer can also review any agreements or contracts you or your real estate agent generated during the selling process.
Taking precautions at the beginning of the sale is critical to ensure proper handling of all paperwork and legalities.
It may save you a tremendous amount of time, money, and aggravation should problems arise with the property. Or on the loan repayments over the years.
How Does Owner Financing Work?
A seller-financed real estate transaction offers benefits to both the seller and the buyer.
But there are some drawbacks for each too when the seller carrying the note, as described below.
Benefits for Sellers Who Hold the Mortgage Note for the Buyer
Even though owner financed home sales are not very common, sellers wouldn't hold mortgages if they didn't benefit.
1. Monthly Income
One of the most significant benefits of an owner carrying the finance agreement is the monthly income it provides to the seller.
Sellers usually accept a down payment at the time of purchase. Then they receive monthly principal and interest payments from the buyer.
For owners not needing a large lump sum of money when they sell their paid-off homes, this adds a source of income with an interest rate that may be higher than some of their other financial investments.
Sellers determine the terms of the loan, including the interest rate and payment terms. They often require a balloon payment of the entire outstanding loan balance after five or ten years.
This allows sellers to collect payments for many years but still receive the balance of their money in a much shorter time frame than a traditional 30-year bank mortgage.
2. Larger Pool of Buyers
Offering seller financing may attract more buyers to your property and allow you to close the deal more quickly.
If buyers don't have to navigate the mortgage process with a bank, the sale of your house may happen in just a few weeks to a month.
In some states, the closing can take up to two months or more when bank mortgages are involved.
3. Higher Profit on Sale
An owner may also be able to sell their property at a higher price when offering a seller-financed mortgage while avoiding certain repairs required by lenders who won't issue a mortgage without their completion.
While the buyer may push back and cancel the deal without the completion of some repairs or at least some negotiation on the cost of them, the seller ultimately gets to decide about selling “as-is” or refusing the offer.
4. Rights to Property in Case of Non-Payment
The ability to foreclose on the property allows the seller to take the property back over if the buyer defaults on payments or walks away from the property.
The owner also gets to keep the down payment and any payments made on the property before the foreclosure.
Benefits of Seller-Financing for Buyers
1. Less Hassle/Time Required
One of the most significant advantages for potential buyers is not having to deal with the hassle and time required to get a bank mortgage.
Owners willing to provide a private mortgage may also have more lenient qualifications than banks or other lenders. This can speed the process and allow buyers to purchase a home they may not otherwise be able to buy.
The down payment may also be less than what a traditional lender would require – helping a buyer who lacks substantial savings but still wants to buy a house.
For buyers needing small mortgages that many banks do not have an interest in extending, owner financing saves time and money over searching for a lender.
2. May Avoid PMI
Buyers may also avoid paying for private mortgage insurance (PMI) required by many banks if a 20% down payment isn't made.
3. Costs Negotiable
If the seller wants a fast sale, buyers may be able to negotiate decent interest rates.
While interest rates may not be as low as a bank offers, seller financing deals often have much lower closing costs for buyers.
If the interest rates aren't great, buyers may get better rates if they refinance when they qualify for a loan or at the time of the balloon payment.
Drawbacks for Sellers Holding a Mortgage
Even though there are many advantages, sellers must understand the negatives of holding a mortgage note.
The biggest concern most sellers have is buyers not making loan payments and not maintaining the property.
The seller then has to enter legal proceedings to foreclose on the property. If the buyer cannot pay what they owe, the seller becomes the owner again.
If this happens a few years into the loan, sellers may have thousands of dollars of profit. But the amount of damage to the property could be significant due to years of neglect too.
If a buyer walks away early on, there may be fewer problems. But less money has been paid to cover legal costs and make repairs over this time as well.
This is why it's essential to get a down payment large enough to cover some major expenses.
Another problem for sellers who provide financing is tying up a large sum of money that could be used or invested in other ways for an extended period.
Lending practices have also affected some sellers' ability to offer financing on real estate in the last decade.
It would likely not impact a seller holding a note for one property, but if you plan to offer seller financing on your home or land, discuss this with your attorney and real estate agent.
Drawbacks of Owner-Financing for Buyers
A buyer may put down a smaller down payment and close quickly on their new home with seller financing. But they may pay more in the long run if the loan comes with a higher interest rate than a bank offers.
Buyers also have to consider how they'll pay off the balloon payment if one is part of the terms of the financing agreement.
Buyers will either need to come up with the funds or seek approval for a bank mortgage. They can't assume the seller will re-negotiate a new loan with them, even if they have been prompt with payments over the years.
Ways Seller's can Protect Themselves
As mentioned before, the legal paperwork required for seller financing should be drafted or at least reviewed by an attorney or qualified professional familiar with the process.
Even if you are selling to family, friends, or someone with stellar credit and long work history – this is not a time to “DIY” legal documents and hope for the best.
You should also consider getting an appraisal on your house, so you understand the market value. This will help you negotiate purchase offers and determine what is an acceptable amount for a down payment.
Talk with your attorney or real estate agent about using a loan application and completing a credit check.
You'll also want to verify the employment history and assets of potential buyers. Checking references is an integral part of the application process too.
Is Holding a Mortgage a Good Way To Make Money?
Depending on your financial circumstances, offering to hold a mortgage as a seller can be a great way to make money and build your wealth.
Financing the sale of your property and creating a win-win solution for you and the buyer may help you obtain a competitive price for your home. And allow you to earn extra money by collecting interest as part of the loan.
As the seller, if you put in the work and money upfront to get the professional help you need, it's possible to find a qualified buyer and make money from seller financing.
There are no guarantees the buyer will follow through, make payments, and keep the property up, though – so there is risk involved. But many real estate owners feel the money they can make holding a note worth the risk.
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Vicki and Amy are authors of Estate Planning 101 – a Crash Course in Planning for the Unexpected -coming soon from Adams Media.