Seller financing offers many benefits for both the buyer and the seller. In many cases, a buyer can purchase a home without a stringent qualification process, and the seller may negotiate a higher down payment. Likewise, these sales often close faster and involve lower closing costs. You might find seller financing particularly attractive if you have bad credit, less-established credit or less stable income. If the seller still owes a mortgage, however, this type of deal can prove tricky.
Free and Clear
The vast majority of seller financing deals happen when the seller owns her home without an outstanding mortgage. Mortgage terms usually prohibit homeowners from transferring ownership of their homes without paying off their mortgages. A homeowner could sell her home to you and accept payments behind the mortgage lender's back, but doing so will most likely violate her contract. Most mortgage contracts include due-upon-sale clauses that require in-full payment upon sale of the home. For example, if you cannot qualify for a mortgage, a good friend might want to help you by transferring ownership of her property and allowing you to pay her directly. Unfortunately, her mortgage contract will probably prevent this.
Paying the Mortgage
A motivated seller might decide to pay off his mortgage to pave the way for seller financing. This can work in a couple of ways. For example, he might use your down payment to pay off his outstanding mortgage, but this will only work if he owes a small mortgage balance. Alternatively, he can use his own savings or obtain a personal loan to pay off the outstanding mortgage and make seller financing a possibility.
You might find some sellers willing to offer wraparound mortgage deals. With this type of deal, the seller retains her original mortgage and keeps the deed to the home in her name, but you get to occupy the property. You and the seller sign a contract and agree on a sale and down payment amount, but you make payments to the seller rather than a mortgage lender. The seller uses your monthly payments to continue paying her mortgage, but she doesn't transfer ownership of the home until you've paid the total amount listed in the wraparound mortgage contract. Though a wraparound mortgage may seem an attractive option, many states and lenders prohibit it. It also represents a risk for both parties. If you default on your payments and the seller cannot pay the amount due, the bank may foreclose. Likewise, the seller could take your money, fail to pay the original mortgage lender and trigger the foreclosure of the property. In either case, you could lose your home.
A seller might offer financing to make up the difference between the amount of traditional financing you can get and the sale price of the home. For example, if you qualify for a loan of 80 percent of the sale price, that leaves you to come up with the remaining 20 percent. The seller may agree to offer financing for the remaining 20 percent by providing you with a second mortgage that you pay directly to him. As long as he does not owe more than 80 percent of the sale price, his lender gets paid in full and you get official ownership interest in the home rather than waiting to have the seller transfer ownership to you years later. The amount the seller finances varies, depending on the buyer's needs. For example, if you have a down payment that amounts to 10 percent of the sale price and an 80 percent mortgage offer, the seller may need to finance only 10 percent of the purchase price.
Seller Holds a Second Mortgage
A seller might also agree to apply for a second mortgage from another lender to help you with financing. In addition to paying your mortgage lender, you would make payments to her to cover the second mortgage on the property. This option can be risky for the seller, however, because it adds to her debt load, and the second mortgage takes a secondary position in a foreclosure. The first mortgage gets paid off first and the second mortgage lender gets whatever money remains. This kind of deal does, however, fully pay off the seller's mortgage and allow her to transfer the property to you.
Sometimes sellers allow buyers to lease their homes with the option to buy. In such a case, you would provide a down payment and make monthly payments that cover the seller's mortgage payment and an agreed-upon amount toward the purchase of the home. Eventually, your payments would add up to the purchase price of the home, and the seller would then transfer ownership to you. Ideally, you would make these payments only until you can qualify for a traditional mortgage and buy the home outright. A lease-purchase arrangement can help you get a foot in the door of home ownership, but in the long run, it may prove more expensive than obtaining your own mortgage.
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