Conventional and government-backed mortgage loans together form the primary source of mortgages for buying single-family homes and small multi-family properties. These require that the buyer go through a full loan application and underwriting process for approval the borrower and the property. Sometimes problems inhibit the sale or purchase of a property. When this occurs, a seller-financed mortgage may provide the solution.
What Is a Mortgage?
A mortgage is an agreement that documents the pledge of a specific real estate asset as security for a loan or debt obligation. A mortgage is also the actual deed or contract pertaining to the mortgage agreement. When mortgage and bank lenders finance the property acquisition, the buyer typically signs a mortgage and a security lien on behalf of the lender. The mortgagor is the mortgage and lien holder; the mortgagee is the person required to repay the debt.
A seller-financed mortgage is an agreement -- between a property's seller and buyer -- through which the seller becomes the mortgagor. Instead of using a bank, credit union or direct mortgage lender to fund the acquisition, the seller funds the transaction. The buyer then makes payments directly to the seller or his or her designee. A seller may provide 80 percent to 100 percent financing and serve as the first mortgage provider. Alternatively, a bank may provide the first mortgage with the seller providing 5 percent to 20 percent financing as a second mortgage.
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A seller who owns a property outright will execute a new mortgage with the buyer. A seller who still owes money on an existing mortgage will use down payment proceeds to pay off the existing mortgage and enter into a new mortgage with the purchaser. Alternatively, a seller who has an existing mortgage on the property that will remain in effect after the closing can utilize a seller-financed wraparound mortgage. The buyer pays the seller, then the seller pays the pre-existing mortgage. For better protection, the buyer could make payments to a mutually agreed upon third party, most often a real estate attorney. The attorney pays the underlying mortgage holder and the seller from the monthly proceeds.
A seller-financed mortgage is an option when a property has issues that prevent it from meeting appraisal standards and thus qualifying for a conventional or government loan. It is used in a buyer's market to enhance the property's appeal or to enable buyers who cannot qualify for traditional financing to purchase the home. A seller may provide a second mortgage if the buyer possesses insufficient down payment funds to buy the property. For investment properties, sellers sometimes provide financing as a personal investment alternative to investing cash received from an outright sale.
Tiffany C. Wright has been writing since 2007. She is a business owner, interim CEO and author of "Solving the Capital Equation: Financing Solutions for Small Businesses." Wright has helped companies obtain more than $31 million in financing. She holds a master's degree in finance and entrepreneurial management from the Wharton School of the University of Pennsylvania.