By Robert Irwin
Your home is for sale "by owner" and, surprise, the second week out a buyer appears with a contract in hand. She wants to purchase your home!
What could be wrong with that? Then you read the purchase agreement and realize, "Hey wait a minute. This buyer wants me to finance her purchase!"
It's time to stop and consider. The buyer is asking you, the seller, to come up with the financing. (This assumes that either you own your home free and clear, or you have substantial equity.) If you go along, instead of cashing out on the deal, you'd end up with a first or second mortgage - paper.
Should you do it? What are the risks involved?
If you're looking for higher interest paper, this might be a good deal for you. Currently banks are only offering a couple of percent on your money. But, a good mortgage in your favor can be written for 6 to 8 percent, today. That's a lot of extra interest.
Or, maybe you're having trouble selling your home and, unlike in our example, this is the first real buyer to come along in months. Perhaps you'd want to go along just to sell that property.
If you do decide to seller finance, a big risk you face is the buyer not making timely payments on the mortgage, and you having to foreclose and take the property back to protect your investment. Depending on your state, the foreclosure process can be short (only a few months) or long (up to a year or more). Further, during that time you'll have no money coming in on your paper, and you might have to make payments on any superior mortgages (as well as taxes and insurance) in order to protect yourself. The foreclosure process itself can cost several thousands of dollars.
Further, when you finally do get the property back, it could be in terrible shape. After all, what motivation would the former buyers/owners (who are losing it) have to keep it in good shape? You might have to refurbish the entire home before you could put it back on the market for sale - another cost.
Of course, there's the other side to risk. With prices going up in most areas, many buyers/owners can resell instead of losing their homes to foreclosure. And if you do take it back, the increased price might end up making you a profit!
If you do decide to finance your buyer, here are three steps you can take to help reduce your risk:
Insist on a large down payment. The more the buyers put into the property, the less likely they are to let it go to foreclosure. 5 percent down would be shaky. 10 percent down would be okay. 20 percent would be better.
Get a credit report and score on the buyers. Good credit and a score above 680 suggests responsible people.
Make sure there's a "subject to" clause in your mortgage so if the buyers sell, you get paid off. And be sure there's a penalty for late payments, which will help you sell the mortgage for cash, if you later need to.
Seller financing is as old as real estate itself. Millions of people have done it successfully. However, that's not to say it's without risk, and many people have been burned.
If it's something you're considering, reread the 3 cautions above. And be sure to have a good real estate attorney assist you and draft your documents.
Robert Irwin is the most prolific real estate writer in America having produced over 100 published books in the field. His TIPS & TRAPS McGraw-Hill series has sold well over a million copies and his FOR SALE BY OWNER KIT and FIND IT, BUY IT, FIX IT and other books have been strong sellers for Dearborn. In addition Irwin writes a regular real estate column for The Wall Street Journal online and is introducing a new weekly column forOwners.com.
Irwin has sold his own property "by owner" and during over 30 years in the business has been a broker and consultant to lenders, agents, buyers and sellers.