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Mario , Home Buyer in San Francisco County,...

What are the pros and cons of seller financing?

Asked by Mario , San Francisco County, CA Mon Nov 30, 2009

I am planning on purchasing a condo with FHA financing. However, I am also potentially able to put down 10% and use seller financing, where the seller will loan me the other 10% of my mortgage at a 7% interest rate for a fixed term, i.e. 5 or 10 years. Has anyone seen this before? Is it better than paying the up front and back end mortgage insurance of FHA?

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Dear Mario,

Here is the opinion from one of my lenders, Dianne Crosby, Senior Loan Consultant, of LaSalle Financial Services, http://www.diannecrosby.com. I hope this helps.

Linda Van Drent, Associate Broker, DRE # 01051129

Seller Financing:

Let’s face it; money invested in the stock market is not performing consistently. “Safe havens,” such as CDs and Bonds are showing very little profitability – it’s hard to get a good return on our money right now! Meanwhile, sellers are reviewing offers from clients who can’t quite make the 20% down payment requirement and FHA financing, the government insured loan is expensive. Is there a better option? Seller financing, secured against the home being sold can be a good solution. The seller might earn 5-7%, a respectable return. The Note may contain a balloon payment after a 5 year period – putting an end date on the deal. The buyer might be able to avoid FHA fees and PMI. Escrow can be accelerated. The downside? If the buyer does not make the payments, collecting on a second mortgage means taking legal action. If the property is abandoned, the holder of the Note must wait until the first mortgage and other primary liens are paid. If you are a seller considering a “carry-back” review the prospective borrower’s income, credit and asset history. This can be a good option if all parties understand the risks and benefits.
0 votes Thank Flag Link Tue Dec 1, 2009
Mario,

Seller financing was used often in previous markets and is seen more frequently now. Becuase financing from traditional lenders has become more difficult, seller financing can be a viable option. For example if a buyer could not qualify for FHA and had 10% down payment, they would need to obtain an additional 10% for the downpayment to qualify for conventional financing. In this case the seller could lend the additional 10% to the buyer.

My advice to you is to really review all the information regarding the seller fiancing scenerio and compare side by side to the FHA scenerio. In addition make sure you fully understand the terms of the loan offered by the seller. Talking to your lawyer and cpa would not be a bad idea.


In this market, where traditional lending avenues can be more difficult to obtain, seller financing can be a viable option as long as you do your homework.

I hope this helped!


Lisa Cartolano
1 vote Thank Flag Link Tue Dec 1, 2009
Mario,
I like seller financiing over both MI (mortgage insurance) and FHA financing for several reasons. With FHA, you have both an upfront Mortgage Insurance premium (UFMIP) along with monthly mortgage insurance with the liklihood of having that removed anytime soon remote at best. You lose the UFMIP right off the top regardless - so that is lost money. Don't get me wrong, for someone who does not have the options you have (10% down, seller carry financing), FHA is the perfect solution. In your case however you have a better option.
Similarily, with conventional financing (10% down payment, 90% loan with mortgage insurance) you will carry the mortgage insurance at least 2 years or more before you can pay it down sufficiently to ask for removal. However, the approvals for MI are very tough, especially in California and if you don't have to carry MI, all the better.
Depending on your income level, the MI would be deductible currently, but you should have no problem writing off the seller financing (check with your tax consultant to be sure). Also, you did not mention the amount of the second, but as long as you do not have a pre-payment penalty on that, you could (and should) focus on paying this down first, eliminating he second alltogether, leaving only the first. Financing this way should get you a better rate and my recommendation then (as long as you are keeping the home 4 years or longer) would be to buy down and lock the rate as low as you can get it. With the end of the Fed buying mortgage-backed securities early next year, banks will begin raising rates as early as this month heading into that decision. Projected rate hikes are 1/2 a point increase by June of 2010 and 1 full point by the end of 2010.
Good luck with this my friend and have a great holiday.
0 votes Thank Flag Link Wed Dec 2, 2009
Although some people often associate seller financing with getting buyers with less than perfect credit into a home, it's far more versatile than this. As an investor, I often prefer to buy/sell using seller financing for several reasons.

I prefer to buy with seller financing, because of the following: 1) I don't have to jump through as many hoops for new financing (ie the underwriting process is shorter), 2) I can close a deal quicker (due to the shorter loan underwriting time), 3) the loan underwriting criteria to refinance are nicer than the ones for obtaining a new loan, 4) sometimes I don't have to put down as large of a down-payment, 5) I'm not subject to the Fannie Mae or Freddie Mac restrictions that limit the number of mortgages that I can have at any given time, and 6) the seller and I have a stake in the property which helps to assure me that s/he isn't trying to leave me high and dry with a money pit. Keep in mind that a knowledgeable seller (whether an investor or not) will thoroughly check a buyer's credit and background; the loan underwriting process still takes less time, because typically only one decision maker (the seller) has to approve/reject the loan request. So, buyers who purchase with seller financing aren't necessarily getting a pass.

I prefer to sell with seller financing, because of the following: 1) I have more flexibility (more on this later), 2) I earn more money, 3) I'll get a higher return on my money than if I were to receive cash and deposit that cash in the bank, 4) various tax benefits (check with your own CPA and/or tax attorney on this), 5) I can attract more buyers, 6) I can use it as a great inflation hedge (check with your own CPA and/or financial planner on this), 7) I can close sooner, 8) I can often flip these deals to other investors quicker than ones for all cash, and 9) I can work around any mind-numbingly annoying seasoning rules. Flexibility is the most important factor to me, because every buyer and deal is different. I could structure the deal with 2 lump sum payments, monthly or quarterly payments, some cash and a hybrid of the previous 2, etc. This flexibility also protects me and the buyer from FHA or other lenders holding us hostage in a deal. Besides, if I want/need some cash, then I could sell some or all of the payments.

I think it's a good idea for buyers and sellers to seek legal council on this.
0 votes Thank Flag Link Tue Dec 1, 2009
If you are considering doing seller financing you really need to be careful how this is set up. First does the current owner have an existing mortgage? Are they planning on putting you on title with them, and what are the terms if you are late for your payment? What kind of fees are they charging? And realistically understand whats in it for both of you. Usually seller financing has a higher interest rate and higher fees, and if they are on title with you might be easier for them to take it back upon default. The advantages would be that you credit isn't the best, you might qualify for a better deal with the private party and it might go quicker. I wouldn't suggest it if you have good credit. Better to pay the mortgage insurance or get a conventional loan and not have a private party involved. Things can get sticky. If you do decide to go that route, I suggest having a local title rep and or an attorney help you with the contracts.
0 votes Thank Flag Link Tue Dec 1, 2009
Well ... why would it be?
0 votes Thank Flag Link Mon Nov 30, 2009
Yes, I've seen it before. You'll have to determine which option works best for you.
0 votes Thank Flag Link Mon Nov 30, 2009
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