How to do a seller-financing deal

Written on February 13, 2018 by

communicationWhat happens when you want to sell a rental property and have a great tenant already living there? Two words—seller financing.

Never heard of seller financing? It’s a simple concept, really. You sell your property directly to a buyer and provide the financing. You, in other words, become the lender in a seller-financing deal. This arrangement works particularly well for landlords and tenants. The tenant is already there!

Seller financing works particularly well for landlords and tenants.

Mary Pitman, a Vero Beach, FL, renter who became an owner, explains how she started the ball rolling on a seller-financing deal.

“My pitch to [my landlord] was he would basically be making about the same amount without any of the expense.” Pitman explains that her landlord would no longer be responsible for paying property tax, homeowner’s insurance, or maintenance and repairs because those expenses would go to her.

“He said ‘yes’ and agreed to owner financing,” says Pitman. “By the time my security deposit, pet deposit, and last month’s rent were factored in, my closing costs were covered, and I had $750 credit.”

Your tenant has already been making payments to you in the form of rent, so you know they’re responsible. And the beauty of seller financing is that neither you nor your renter need to put out any effort—other than some paperwork—to complete this real estate transaction. No hiring a real estate agent to sell your home. No listing, staging, showing, or waiting for someone to make an offer. You already have someone who wants your house.

After you set up a seller-financing transaction, allowing your renter to buy your property, the payments the seller makes to you will go toward buying the house.

Seller financing is especially attractive to homebuyers who don’t qualify for a mortgage. This makes these buyers risky. But in this case, the buyer is someone you already know—your tenant. Because you have a relationship with this person, you know whether they are responsible and can afford to continue making payments to you. If they’ve been a good tenant so far, the risk factor is reduced since you already have a history with this person.

So what are you waiting for?

Here’s how to set up a seller-financing deal:

1. Get a professional to help you

Seller financing, although a simple concept to understand, can be complicated to set up. It’s a good idea to hire a real estate attorney to structure the deal and a tax professional to help ensure you set up the deal advantageously to you.

Just because you’re hiring pros doesn’t mean your job ends. If you will be entering into a big financial transaction such as this, it’s a good idea to understand as much as possible. These next steps will give you an idea of what you can expect to happen.

2. Write a promissory note

A promissory note is a legal document, like a lease, and is used in place of a mortgage loan. Its purpose, like a lease, is to spell out the details of the deal. The promise part of the promissory note is the buyer’s promise to pay you for the house. All the details of the deal will be listed in the promissory note, such as repayment amount, interest rate, terms, consequences of nonpayment, and how much of a down payment you require. Seller and buyer both sign the note.

3. Use your home as collateral

Your home acts as collateral on the promissory note. If your buyer defaults on payments, the deal is off, and you keep the house.

4. Accept a down payment

You can be flexible here. Although you can do a seller-financing deal and ask nothing for a down payment, it’s better if you collect something. This makes it less likely for the buyer to walk away, and you get to keep the down payment if they do. Collecting 10 percent or more would be something to shoot for.

5. Figure out how much interest to charge

You’re a lender here, so you deserve to collect some interest on your loan. You, however, don’t have to turn into a loan shark. Ask for interest comparable to what the banks in your area charge.

6. Structure the loan with a balloon payment

You may be acting like a bank in a seller-financing arrangement, but you don’t want to wait 30 years to get your money. Avoid that by amortizing the loan as a 30-year loan so your buyer can afford the monthly payments. But structure the loan so the balance is due in a short time.

A standard time frame for this is five years. After five years, the loan will be due. Your buyer, presumably, would have built up their credit at this point, having paid you consistently and on time for the past five years, meaning they can now get a traditional loan from the bank.

Optional: Sell your promissory note to an investor. If you have an attractive deal set up, such as a good buyer, a quality home, and a loan with favorable terms, and you want cash now—maybe to buy another rental property—consider selling your note to an investor. Note that you might need to discount the price of the note to sell it.

Bottom Line

It’s easiest to enter into a seller-financing arrangement with a house you own free and clear. If you still hold a mortgage on the house, you’ll need permission from your own lender to do the deal.

But if this is a good fit for you, seller financing is something to consider.

Have you done a seller-financing deal as a buyer or a seller? Let us know how it worked out for you in the comments!

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9 CommentsLeave a Comment

  • Jenny Chien

    Seller financing might just be the answer. Just because banks aren’t approving borrowers easily it certainly does not mean that you can’t sell your house quickly and for what it’s worth. Even if your financial situation might be complicated than traditional lenders do prefer, it doesn’t mean you can’t buy a property.

  • WILLIAM BIBBUS

    I want to buy the house I have been living in for 11 years, the property owner is going to carry the loan, it is a relatively inexpensive home, given that, the owner does not want to charge interest for the three year loan, is this legal, can he sell me the property and hold the mortgage and not charge interest?

  • Holly Darling

    With ‘Owner financing’, is it legal for the landlord to add stipulations to his Sale Agreement as, if a payment is late, he will forego the foreclosure process with the court and foreclose immediately, OR state that if my husband & I ever plan to divorce that the person leaving the house does not have a financial interest in the property?

  • Denny

    Lots of bad information in this article . According to Dodd frank you can’t have balloons so that’s illegal . You also would be a fool to charge what a bank charges ! Your taking on way more risk by offering a house to a person who can’t get a traditional loan there’s a reason for that ! You must set your interest 5 points over prime to make it work . You left out if they don’t pay you must legally foreclose on the person . You have strict standards you must conform to its Way more tricky than what is talked about in this article . Clearly the author has never even done this strategy before

  • Alan

    This article could benefit from a thorough description of loan servicing, costs, who pays that, etc.

  • Mike Justice

    How does a real Estate Investor, Legally offer owner financing to home buyer ? The Dodd Frank Act says if your a LLC or Corp etinty, You can on do 3 seller financing deals per year? The Way I understand the laws is you must have at least one person / partner in your computer that is a listened real estate agent or mortgage /Broker, Loan originator, underwear and loan servicer company to be in complicated, Can anyone give me some insight on what to do or the easiest way from a investor the offer multiple sell it financing deals a year Legally ?
    Thank You,
    Mike Justice

  • Maria

    Hi I have a question.
    I’m about to purchase my first house.
    The owner is going to carry the loan.
    He owns it outright.
    We agree with no interest, 10 year agreement. $528 monthly, with $5k down payment and $5k balloon once a year.
    No fees if paid off sooner then agreement date.

    What I am wondering is what type of contract I need? What steps do I need to take because the owner is also lost, he has never sold a home before.

    I’m aware this involves 2 documents, promissory note with our agreement.
    And a warranty deed for the state of Oregon.
    But I’m not exactly sure the steps to take here

    Also a friend mentioned I need to get it amortization to protect me from forcloser.
    I don’t fully understand that term.
    Thank you for your help in advance

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