Covering Your Assets with Seller Financing

While “seller financing” may sound like a scary term to most people it is actually a very powerful tool for increasing the value of your property.  The main reason that seller financing will add value to your property is that you increase the number of people who can qualify to purchase your property because you control the qualification standards.  The more people who can buy your home the more valuable it becomes (the basic law of supply and demand).

“Equity Only” financing is exactly what it says, the owner only finances the equity they have in the home.  The way this works is the buyer is required to secure their own financing equal to (or greater) than the owner’s underlying mortgage.  The loan proceeds from the buyer’s loan will pay off all indebtedness of the owner and remove the owner from future liability.  The balance of the purchase price is then financed by the owner to the buyer.

Why would this be a great deal for everyone?  The owner is able to sell a home more quickly than other comparable homes on the market and for full market value (sometime more).  The owner is also able to dictate the terms of the financing to meet their needs.  The buyer has an easier time to qualify for their conventional loan and may even qualify for better rates (depending on the LTV of the loan).  The mortgage broker gets new business and a lender gets a new loan to service.  Any real estate agents involved with generate commissions.  The wheels of the economy turn and everyone is happy.

While there is no such thing as “no risk”, the owner in this situation has very little risk.  If the buyer pays as agreed then the owner collects interest on their equity and will still preserve all of their equity too.  However, should the buyer fail to pay, the owner is in a powerful position to take the house back (through foreclosure) and then sell it again.  The foreclosure costs would be paid by the 1st mortgage and the original owner is in a strong position to simply buy back the property.  And should the home be bought by someone else at the foreclosure auction, any dollar amount over the 1st mortgage is paid to the previous owner, thereby allowing them to collect their equity at the foreclosure auction.

Example:

Let’s assume the home is worth $100,000 and the owner has 20% equity ($20,000).  By offering seller financing the owner could probably sell the home for $105,000 but we’ll assume that it is sold for $100,000.  The buyer would then get a loan for $80,000 and the seller would finance $20,000 (for a $100,000 purchase price).  Because the conventional loan amount is only 80% there would be no mortgage insurance which reduces the mortgage costs to the buyer (making it an even better deal). 

The seller was going to use the $20,000 as a down payment to buy the next house for $200,000.  With 10% down payment the seller would have had a loan for $190,000 at 6% interest with a mortgage payment of $1,140/mo.  Without the 10% down payment the seller gets a loan for $200,000 at 6.25% for a payment of $1,230/mo.  So the seller offers the $20,000 seller finance note of the sale of the first house at 7% interest only which gives $115/mo payments to off-set the difference for the second house payment.  In the end, the seller is better off by $25/mo.

But what if the seller is able to sell the home for $110,000 instead of $100,000?  Then the buyer still gets a loan for $80,000 and finances $30,000.  $30,000 at 7% interest only payments is $175/mo which is $85/mo better than an outright sale.  And when the buyer sells (or refinances) the property the seller will net an additional $10,000 of equity.  Over 5 years this would equal an additional $15,100 for the seller ($10,000 additional equity and $5,100 additional payments).  So the seller makes an additional 15% on the sale of their home using this form of seller financing.

What we must learn and remember is that seller financing is better for the seller than it is for the buyer.