As a beginner, learning to invest in real estate can feel like a never-ending learning curve.
When you’re looking to get into investing or rental properties, figuring out how to get funding for the deals and navigate through the funding process can add to the frustration you’re going to experience.
Taking the time to get to know each possible funding solution, working together with outside parties, getting familiar with the approval process, and then getting to closing can be absolutely mind-numbing.
So if you’re looking for a way to make things as easy as possible to help get your first (or next) deal done without giving yourself a migraine, you might want to look into using seller financing.
In this guide, we’re going to break down exactly what seller financing is, why it’s so much easier to use, and how to decide if it’s the right funding strategy for your specific situation.
To get things started…
What Is Seller Financing?
Typically, investors use traditional mortgages to purchase their investment properties.
This involves using a third-party financial institution to issue the loan and, with it, typically comes a long, drawn-out process to get approved for the loan.
It also includes lengthy terms — ranging from 15 to 30 years in most cases.
However, with seller financing, the owner of the property agrees to let you purchase the property without using a bank. It’s an agreement established between yourself and the seller where you’ll make payments directly to them instead of a bank.
With seller financing, the seller is effectively issuing you a line of credit.
They are acting as the bank in the transaction and giving you anywhere from 5 years (in some cases) to upwards of 30 years to repay the line of credit they’ve given you and take ownership of the property.
Why Use Seller Financing?
When the seller owns their property outright, seller financing can be a great way for you to invest in real estate without involving traditional banks.
If you’re looking for a property that you can quickly fix-and-flip, for instance, using seller financing may help you get better interest rates and more affordable terms than a bank would give you.
On the seller’s side, financing the deal themselves is a great way to earn immediate passive income on the property and start putting those payments in their pocket right away.
It’s also a great option for sellers who want to minimize their capital gains taxes by extending their income from the property over a number of years instead of having them all come due in a single year.
With seller financing, investors are able to move quicker and can renovate the fix-and-flip or turn it into a rental property without the lengthy approval and closing process through traditional banks.
Sellers also get the benefit of immediate passive and residual income from the property while both the seller and the buyer get to benefit from more favorable tax structures.
Advantages Of Seller Financing
When available, seller financing is a great way to get deals done and comes with a few key advantages over traditional mortgages.
- It’s generally less stressful than getting banks involved in the process.
- It’s easier for buyers to qualify for the agreement since there’s no banks involved.
- The amortization periods tend to be shorter, helping you own the property faster.
- The closing process is easier with far fewer costs.
- Sellers can generate higher interest rates.
- Sellers typically won’t need to upgrade or renovate the property before selling it.
- The seller can reclaim the property in the event of a foreclosure.
Drawbacks Of Seller Financing
If you’re looking to use seller financing to help close more real estate deals, you’ll want to understand the disadvantages to ensure you’re able to navigate through them.
- The paperwork can be intensive since the seller is assuming the risk.
- You may find it difficult to find sellers willing to finance their properties.
- Sellers will have to oversee and collect on the loan themselves.
- Down payments are larger, interest rates are higher, and the repayment period is shorter than a traditional loan.
- Sellers will receive less cash upfront and may potentially have issues collecting payments.
- Homes with mortgages are typically unable to be financed by the seller.
- Sellers assume the foreclosure risk which can be higher in most cases.
As long as the advantages outweigh the drawbacks, using seller financing can be a win-win situation for both you and the seller.
Types Of Seller Financing Agreements
One of the biggest benefits of seller financing is the freedom for the buyer and seller to negotiate the terms of their agreement between themselves instead of having a traditional bank set the terms for them.
And when it comes to negotiating the agreement, there’s a few common strategies to use.
Mortgage (Full or Partial Price)
On a mortgage agreement, the seller will provide the buyer with a mortgage for either the partial or full purchase of the property.
In a full price agreement, the seller provides a standard mortgage — similar to what a bank would provide.
In a partial purchase agreement, though, the seller would finance a portion of the deal with the remainder being made up in either cash or a traditional loan as a lump sum payment due at the time of closing.
Installment Agreement
An alternative to a traditional seller-financed mortgage agreement is an installment agreement.
These agreements revolve around making payments on the property over a specified period of time, including both principal payments and interest payments.
In these agreements, the seller will hold the title of the property until the buyer has fulfilled their financial obligations outlined in the agreement.
Trust Deed
A deed of trust, or trust deed, is used when the buyer obtains a loan through a separate party with the property being held in a trust until the third-party has been fully repaid.
In this instance, you (as the buyer) obtain a loan through another investor then pay the seller. The deed to the home would be placed in a trust until the investor you obtained a loan through has been fully repaid.
Lease Option Agreement
In a purchase agreement or lease option, the seller will lease the property to the buyer. The buyer will retain the ability to purchase the property outright at any point in time for an agreed price.
Then, when the term expires, the buyer can either finalize the purchase by applying their regular lease payments to the final purchase price or opt to completely forfeit their lease and walk away from the property.
How To Find Seller-Financed Properties
Given the situation, many sellers are not open to financing the agreement themselves.
However, there are a few key ways you can locate owners who will be open to seller financing.
Some of those strategies include:
If you’re looking for even more ways to find motivated sellers who might be open to seller financing, check out our guide: 12 Ideas For Finding Motivated Sellers (With Examples).
You can also take a look at our guide on finding & buying abandoned properties in any market.
The key here, though, is looking for situations where an owner may be motivated to sell their property to you WHILE allowing you to enter into a seller financing contract.
Then, you’ll want to understand what those contracts look like, how to navigate your way through them, and how to determine whether or not it’s still a good deal after seeing the terms.
What A Seller Financing Contract Looks Like
Seller financing contracts look similar to a traditional mortgage or bank financing agreement but the primary difference is that the buyer will be paying the seller instead of the bank.
A standard seller financing agreement dictates:
- The upfront cash down payment.
- The total asking price.
- The interest rate.
- The amount being financed.
- Whether or not a balloon payment will be required.
- The total balloon balance due.
- The amortization period.
- The total of payments made to the seller.
Something to take note of is that a seller financing agreement may also be referred to as a “seller carryback” since the seller will hold the financing — or carry it back.
Seller Financing Examples
To help wrap your head around why a seller would want to finance their property to you or why these can be such an easy and lucrative investing strategy, let’s take a look at a common example.
Let’s assume that a seller has listed their property for sale for $250,000 but the property isn’t necessarily in pristine or show-ready condition so realtors are having a hard time selling it.
You may be able to offer them a full price for their home but request that they finance the property themselves with 20% down or $50,000.
If they’re open to the arrangement, they’ll get the property sold while you’ll get into the property for your $50,000 down payment.
If the seller no longer has an open mortgage on the property, they may be likely to accept your offer because it will be a large cash injection while also providing them with consistent passive residual income.
In this instance, the buyer may ask you to make payments of $1,500 per month on the property which would be higher interest than what they may get from the stock market.
Over the course of the agreement, the seller would receive more money from the deal than they would have if they were to initially sell the property outright for $250,000.
Frequently Asked Seller Financing Questions
Here are some of the most frequently asked questions with the seller financing strategy.
Who keeps the title?
In a seller or owner financing agreement, the owner of the property will retain the title. Once the loan agreement has been fulfilled, the owner will transfer deed ownership to the investor or buyer.
Do you need to use a title company?
While it may not necessarily be required by your state, a title company can help protect you from costly mistakes or hidden issues from past owners.
It’s worth using a title company to avoid being caught up in someone else’s problems where the title to the property is concerned.
Does it affect your credit?
For the most part, seller financing will not affect your credit because the owner is financing the property themselves instead of going through a traditional bank.
However, the exception to this rule is if the owner of the property maintains a business entity that opts to report to the credit bureaus.
In this case, your credit score could be negatively impacted if you fail to fulfill your obligations in the agreement and the owner reports you to a debt collection agency.
What if you have a mortgage?
If the home has an active mortgage on it, you will need to ensure that a seller financing agreement does not violate the terms of the original mortgage.
To give you an example, some mortgages include a due-on-sale clause that means the original lender will demand a full payment on the remaining balance if they find out that the seller is attempting to sell the property in a seller financing arrangement.
Should You Use Seller Financing?
If you’re looking for an easier way to fund your investment properties or you’re looking for a new strategy to add to your funding toolset, seller financing can be a great option.
It’s typically a win-win situation for both parties, with you gaining access to the property so you can fix-and-flip or buy-and-hold, while the owner of the property gets a large cash injection and a consistent income stream that helps them earn more than they would by selling the property outright.
For even more funding strategies you can use, check out our guide on creative financing.
