So, you want to buy a home with the seller financing the deal.
Generally, this is not a good idea for many reasons. Mainly, if there is anything we have learned in this ongoing recession, it is that contrary to the thinking of past years, people do often lose money in real estate. To avoid that, people should buy the RIGHT property that fits all the RIGHT reasons that they want to own real estate and a particular property.
Why It’s Not a Good Idea to Buy a Seller-Financed Home:
1. Not credit-worthy — Buyers who are interested in seller financing are often people who cannot get traditional long-term, low-interest financing because they have some credit issues. For these people, the bank is telling them that they are not currently creditworthy. These people should generally avoid making large, risky purchases like real estate where they may get in over their head. They should instead work hard over the next few years to get into a creditworthy position where traditional financing is available.
2. Not the right property — To add to issues for buyers, seller-financed houses make up a very very small percentage of the overall real estate market. There might be 1-3 seller-financed houses for every 100 for sale. With those odds, the chances of a seller-financed house being the RIGHT property for a particular buyer for all the RIGHT reasons is very low. So don’t buy, just to buy!
3. Not a good deal — In addition, many seller-financed deals are properties bought for cash by investors who are selling them to inexperienced and non-creditworthy buyers at either above-market prices, or above-market financing rates on short-term loans, or both. And that is a recipe for getting the buyer into deeper financial problems and losing the property just a few years down the road.
When You Add Up 1 + 2 + 3 You Have a Buyer Who:
- Isn’t really in the financial position to buy real estate,
- Is going to buy a house that probably doesn’t really match what they want and need
- Is possibly paying an above-market price and above-market interest rate on short-term financing.
Even a first grader can add up those numbers and realize it’s simply not a good idea.
Traditional Sellers/Owners with Mortgages
There are also seller-financed deals called “all-inclusive trust deeds” and “wrap-around financing.” Both of these are basically sales where the existing mortgage stays in place and the seller offers some additional financing behind the first trust mortgage deed. In almost all cases, this violates the existing mortgage agreement’s “due on sale” clause. While many people have done this, it just isn’t a good idea for a buyer to get involved in one of these situations. The buyer is taking on a lot of additional risk and potential problems down the road.
What If You Are the Seller?
For a traditional owner trying to sell a property, or a less experienced investor, you are selling a property to someone who the bank has deemed not financially able to buy real estate. Remember the term “subprime mortgage?” We do not hear that term any longer because banks were burned badly on subprime loans and they are no longer issued. A seller needs to understand that there might be a little additional risk in trying this strategy.
This is not to say all seller-financed deals will fail. It just means chances are slim that it is going to be a fair deal for the buyer and a safe deal for the seller. In most cases, there are better courses of action for all parties.
If you are going to do one of these, make sure to get adequate legal advice. The rules, laws and disclosures on financing are extensive and if you do not properly dot your I’s and cross your T’s it could become major trouble down the road.
As always, spend your time finding the RIGHT property that works for you for ALL the reasons you want to own property and that particular property. And for the long term.
Leonard Baron, MBA, CPA, is a San Diego State University Lecturer, a Zillow Blogger, the author of several books including “Real Estate Ownership, Investment and Due Diligence 101” and “Buying a House, Condo or Townhome – Guide to Smart Purchasing” and loves kicking the tires of a good piece of dirt! See more at ProfessorBaron.com.