Can a House With a Mortgage Be Sold With Owner Financing?

Buying and selling a home can both be hugely stressful. You're focused on finding the right house that is within budget and meets your family's wants and needs, or you need to find a buyer who is willing to pay what your home is worth. However, even after an offer is made, the whole exchange can be undone if someone has trouble getting financing. One way around strict lending restrictions (especially since the 2008 financial crisis) is through seller financing. However, this can't always be done legally if the seller has a traditional mortgage on the home.

Seller financing occurs when a seller lends a buyer the money to purchase a property instead of the buyer getting a loan through a traditional lender, like a bank. There can be advantages for both parties. Sellers might find a buyer more quickly, since seller financing is considered a perk by some buyers. Buyers are able to have more flexibility in their loan terms, including the down payment amount. Plus, the closing can happen more quickly, which often benefits both parties.

Seller financing is sometimes known as a wrap-around mortgage. The idea is that the new loan, which is for a higher amount than the original mortgage, will "wrap around" the original mortgage. For example, the buyer of a $200,000 home that was seller financed would make payments on that amount to the seller. The seller, who had a $150,000 mortgage on the home before the sale, would continue to make payments on that amount to his original lender. Therefore, the amount the seller receives from the buyer each month would wrap around, or cover, the existing mortgage amount.

There are many risks to seller-financing options, including the risk that either side may fail to hold up his end of the agreement. However, a bigger issue is that the existence of a due-on-sale clause can mean that using seller financing on a property with a traditional mortgage violates the terms of that agreement. Due-on-sale clauses dictate that the entire amount of a mortgage is due when ownership of the property transfers hands, with some exceptions for instances like inheritance or divorce. This means that a new payer cannot simply take over the terms of the original mortgage. If a lender finds out that this is effectively happening through a seller-financing agreement, the original lender can demand that the entire mortgage amount be paid immediately, leaving both the buyer and the seller in a predicament.

One way to utilize seller-financing options if there is a due-on-sale clause in place for the original mortgage is to conduct a lease purchase, which is sometimes known as a rent-to-own agreement. Under these agreements, the potential buyer agrees to lease a home at above-market rent. The purchase price of the home may or may not be set before the actual sale, and the surplus amount that the potential buyer pays each month is credited as a down payment against her future purchase of the property. After a set amount of time, the potential buyer obtains financing on her own and uses that to complete the purchase of the home. Since the change in ownership doesn't actually occur during the lease time, these agreements do not violate due-on-sale clauses.

There are many things to think about when considering owner financing, particularly if the home is already mortgaged, to make sure that both buyer and seller are protected and acting legally.