You may have seen a sign driving through a neighborhood in Phoenix or anywhere else in Arizona that reads seller financing. You may ask yourself, what is seller financing, and why would I want to know about it?
If you are interested in buying your home or selling your house fast, then seller financing is a term that might interest you and have potential benefits for your situation. Essentially, seller financing is sometimes known as Owner Financing.
In Arizona, many investors look for seller financing deals, and many people that want to sell their houses fast will think about using seller financing to sell their homes. But what is seller financing, and is it the right decision for you?
Seller Financing: Overview
Owner financing, or seller financing, is when the owner (seller) of the property retains ownership of the property and finances the purchase of the property for the buyer.
How does owner financing work for real estate investors? A real estate investor looking to purchase a property will often negotiate seller financing with a seller who does not have a mortgage on the property.
The buyer then agrees to pay back the seller over time, usually through a promissory note.
There are many good reasons for the buyer and the seller to enter into an owner financing transaction. For the buyer, seller financing is a relatively easy way to get into a property with little or no money down.
For the seller, owner financing can be a great way to sell a property with little or no cash out of pocket or sell the property fast with no fees or fuss. Seller financing is similar to bank financing. However, the buyer pays monthly payments with agreed interest rates over a certain period with an agreed-upon set of terms.
Sometimes Seller Financing can be called seller carry-back financing.
Motivations of Seller Financing
So why exactly would someone partake in seller financing? Understanding the motivation behind things helps you gain a deeper understanding.
At the moment, in Arizona and the rest of the country, even though house loans or mortgages have very low-interest rates, it is hard to get a mortgage to purchase a property.
The property market is currently in a slow period of growth. This means that banks and lending institutions are very cautious about their lending. There’s a risk that property prices will fall, making them lose money. It’s always a good idea to buy a property from the owner rather than buy it from a real estate agent.
This is one of the best ways to get a good deal. It’s a way to get a loan without needing to go through the rigmarole of the application process. Owner financing is a way for the buyer to get the money to buy a property. It’s a way to get a loan without needing to go through the application process.
The seller will provide the buyer with a loan for the property's purchase price. The buyer then pays the seller for the property and the interest on the loan.
Seller Financing Arizona Laws
Always know the laws when entering a seller financing deal, whether you are trying to sell your home fast or looking for a good deal. Each state may have laws and regulations for seller financing on top of federal laws. It is noted that the information we provide is for informational purposes only, and we would advise contacting an attorney, tax advisor, or professional consultant.
A downside for the seller under Arizona law is the only fix is if the buyer starts defaulting on the property. The seller can then foreclose the property. This is bad for the seller because the buyer foreclosure is a lengthy process, and essentially the defaulting buyer gets free rent during the foreclosure process.
A promissory note and a deed of trust is needed in for a seller
Deed of Trust- A Deed of Trust is an agreement between a borrower and a lender to transfer the home to a neutral third party. They will serve as a trustee who holds the home until the borrower pays the debt. During repayment, the borrower retains the actual or equitable title to the property. The borrower also maintains full accountability for the premises unless stated otherwise in the Deed of Trust. The trustee still holds the legal title to the home.
Promissory Note- This is an IOU or a loan agreement. It's a legal lending document that says the borrower agrees to reimburse the lender a certain amount of money in a certain period. This document is legally enforceable and creates a legal necessity to pay the mortgage. In this case, the promissory note would be used to set the interest rate, the terms or consequences in case the buyer defaults, and the schedule of the payments.
Federal laws also need to be accounted for, like the Dodd-Frank ACT. Again, this is a complicated act that seems to have conflicting aspects. In short, it states that the creditor or the seller has to have a good faith determination or reasonable way of determining that the buyer can pay back the mortgage before creating the mortgage.
Basically, under this act, anyone who negotiates the terms of a residential mortgage will be considered a "mortgage originator." This means you will have to be a licensed mortgage broker. Although there are some exceptions, here is the one property exception that deems you not the "loan originator" and means that you can seller finance the property:
A natural person, trust, or estate
can only provide financing to 1 person in a 12-month period
They did not build the house or act as a contractor when the house was built
When the loan is re-payed it cannot end up in negative amortization
You can use balloon payments as part of your arrangement, however, most believe it can be no shorter than a 5 year period
Even though adjusted rates are not prohibited, a fixed rate is better suited
And here is the " Three property exception":
Must be a natural person, trust, estate, or an entity
you are providing financing for three or fewer properties in the twelve-month period
you must own the property you are securing
didn´t build the house or contract it
the loan is fully amortized and there are no balloon payments
a fixed rate is suggested
the seller must do a good faith determination and investigation to check if the buyer can repay the loan
However, some of this act has been repealed by president Trump so it is important to contact a legal authority if you are wondering about certain aspects of the DFA
Different Seller Financing Arrangements
Let us look at the different type of seller financing arrangements that are typically used
This contract gives a sort of temporary shared ownership or an "equitable title". After the buyer is done making all the payments to the seller, they get the deed.
This is similar to an ordinary rental where the seller leases the property to the buyer, except they both agree upon a future time and price that the buyer can buy the property. All or some of the rental payments are credited to the purchase price (some variations).
Today some lenders are unwilling to lend money that covers more than 80% of the home's value. Then the seller may credit the difference. However, some banks may not be willing to provide the first mortgage because the buyer would be carrying a lot of debt, which is risky.
All-inclusive mortgage or (AITD)
This arrangement is the typical Seller financing option. The seller will carry the promissory note and the mortgage for the total home price balance minus any down payment.
Allow the buyer to switch on the place with the seller on the existing mortgage. Some FHA, VA loans, and conventional adjustable mortgage rate (ARM) loans are assumable. Of course, with the bank's approval on the mortgage transfer.
Advantages of Owner Financing
Owner financing may be a great option for both parties in a real estate deal:
Pros for the Buyers
Quicker closing: You don´t have to wait for the bank loan officer, underwriter, and legal department to process and to approve the application.
Reduced closing costs: There are no bank fees or appraisal costs.
More flexible down payment: There are no bank/government-required minimums.
A good alternative for buyers who cannot get financing: If you cannot secure a mortgage, then this is a good option!
Pros for Sellers
Sell "as is": Sell your home fast in Arizona without making costly repairs that the traditional process might require.
An excellent investment: A potential to earn more favorable rates on the money you raised from selling your home than from investing other ways.
Retain the title: If the buyer defaults, you get to keep the down payment, the money that was paid, and the house.
Sell fast: You may be able to sell and close quicker since the buyer avoided the traditional mortgage process.
Personal Insight: "I've had a few roofing clients purchase their homes through owner financing and then just get their roof repaired over getting the roof replaced because they bought the house in as-is condition. They were able to stretch the life out of their roof with the repairs until they could gather more funds to get the rest of the roof replaced. Owner financing was a solution that gave them access to homeownership!" Brendan Anderson | Brix Systems | Kalispell, Montana.
Disadvantages of Owner Financing
Although owner financing can benefit the buyer and seller, it has some legal, financial, and logistical disadvantages:
Cons for the Buyers
Higher interest: Most likely you will pay a higher interest rate than a bank
You still need the seller's approval: Even if a seller is for owner financing, he still might not want to become your lender.
Due-on-sale clause: If the seller has an existing mortgage on the property, their bank/lender can demand immediate payment of the debt (in full) if the home is sold (to you). Most mortgages have a due-on-sale clause, and the bank can foreclose if the lender is not paid. To avoid this risk, ensure the seller owns the house free and clear. Otherwise, check that the seller's lender agrees to owner financing.
Balloon payments: Large balloon payments are due after 5 years in many owner-financing arrangements. If you cannot secure financing by then, you may lose all the money you've paid and the house.
While even the most sophisticated sellers are not likely to subject borrowers to the harsh loan approval procedures that the traditional lenders use, this does not mean they will not run a credit check on you. You may be turned away if you are a credit risk.
Cons for Sellers
Dodd-Frank Act: With the Dodd-Frank Wall Street Reform and Consumer Protection Act new rules were employed for owner financing. Balloon payments may not be an option and you may have to include a mortgage loan originator. This depends on the number of properties you owner-finance each year.
Default: The buyer could quit making payments at any time during the amortization period. In this event the buyer just doesn´t leave; you have to foreclose the property.
Repair costs: If you end up taking back the home for whatever reason, you may end up paying for repairs and maintenance this depends on how well the buyer cared for the property.
Our Tips: Reducing the Seller's Risk
Many sellers are hesitant to underwrite a mortgage. They fear the buyer will default (not make the loan payments). However, the seller can take certain steps to lessen the risk of default. A professional can assist the seller in doing the following:
Require a loan application. The seller should require the buyer to sign a detailed loan application form, also thoroughly check all of the info the buyer adds there. This entails doing a credit check/vetting employment, assets, financial claims, references, and other background information and documentation.
Allow for seller approval of the buyer's finances. The written sales contract -- which specifies the terms of the deal along with the loan amount, interest rate, and term -- should be made contingent upon the seller's approval of the buyer's financial situation.
Secure the loan with the home. This way the seller (lender) can foreclose if the buyer should default on payments. The house should be correctly appraised at to validate that the value is equal to or more than the buying price.
Request a down payment. Traditional lenders will ask for down payments to give a sort of cushion against the possibility of losing the investment. It also makes the buyer less likely to walk away if they run into financial trouble. Sellers should collect at least 10% of the purchase price as a down payment. Otherwise, in a weak market, foreclosure could leave the seller with a house that can't be sold to cover all the costs.
In conclusion, it is advised for you to seek an attorney or lawyer when deciding to either buy a house that is seller-financed or finance your own home to a buyer, as there are apparent risks in doing so. However, we hope you found our article informative! We offer buyer financing on some of the properties we sell, so it always helps to connect and discuss your situation to decide if it's the right option.
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