2. Introduction
This lesson will cover:
how seller financing works
why seller financing is used
forms of seller financing
alternatives to seller financing
agent’s responsibilities in seller-financed
transactions
3. How Seller Financing Works
Two ways for seller to finance buyer’s
purchase:
purchase money loan
land contract
4. How Seller Financing Works
Mortgage or deed of trust
Seller is extending credit to buyer, not
providing loan funds.
Buyer makes installment payments to
seller.
Seller is mortgagee or beneficiary, with
right to foreclose in case of default.
5. How Seller Financing Works
Contract for Deed
Buyer (vendee) takes possession of property,
but seller (vendor) retains title until contract
price paid in full.
Alternative to a lien.
Seller extends credit to buyer.
6. How Seller Financing Works
Seller financing may be:
primary financing
seller is buyer’s main or only source of
financing for purchase
secondary financing (seller second)
supplements primary loan from
institutional lender
covers part of downpayment or closing
costs required for primary loan
7. How Seller Financing Works
Choosing finance instrument
Seller generally decides which type of finance
instrument
Real estate lawyer should
prepare/review.
Deed of trust: trustee must be appointed.
8. Why Seller Financing is Used
Seller financing can:
attract buyers when interest rates are
high
help buyer qualify for institutional loan
enable seller to charge higher price
provide tax benefits to seller
9. Why Seller Financing is Used
Seller financing:
seller isn’t bound by institutional policies
regarding yields, loan-to-value ratios, or
qualifying standards
not an option for seller who needs to be
cashed out quickly
10. Seller Seconds
Seller second:
buyer paying most of purchase price with
institutional loan
seller accepts second mortgage for
remainder
11. Seller Seconds
Supplementing a new loan
Seller second supplementing new
institutional loan must meet institutional
lender’s standards.
Combined loan to value (CLTV)
Credit
Income and debt ratios
Assets (including reserves)
Terms
12. Supplementing New Loan
Buyer’s situation
Factors in buyer’s financial situation may
shape design of seller second:
funds available for down payment
buyer’s qualifying for total monthly
payment
interest rate
balloon payment
13. Supplementing New Loan
Buyer’s situation
May be easy to refinance seller second with
balloon payment if:
property has appreciated substantially
interest rates are low
But if interest rates are high or property has
lost value, refinancing could be difficult.
14. Supplementing New Loan
Seller’s situation
Seller’s evaluation of second:
cash at closing
monthly income
timing of payoff (balloon payment)
yield on investment
tax consequences
lien priority
15. Seller Seconds
Supplementing an assumption
Seller second can supplement buyer’s
assumption of seller’s existing mortgage.
Buyer makes payments on seller second
to seller.
Buyer takes over monthly payments on
seller’s existing mortgage.
16. Seller Seconds
Supplementing an assumption
Assumption only possible if:
existing mortgage doesn’t have due-onsale clause, or
lender agrees to assumption.
Needed to release seller from liability.
Usual underwriting standards to
evaluate buyer assuming loan.
17. Seller Financing as Primary Loan
Unencumbered property
Seller financing is most flexible when seller
has clear title to property.
Buyer and seller negotiate price and
terms
Buyer may need less cash
May not have discount points or
origination fees
Lower closing costs
18. Unencumbered Property
Protecting seller’s security
First lien position if finance instruments are
recorded.
Seller should still be concerned with:
property taxes
special assessment liens
hazard insurance
19. Unencumbered Property
Protecting seller’s security
Failure to pay taxes or insure property should
be grounds for default under the finance
instrument.
Seller can require impound account.
If not, seller should require proof be sent
to him.
20. Unencumbered Property
Institutional second
Buyer might want to supplement seller
financing with secondary financing from lender.
Seller should investigate terms of
proposed second loan before agreeing to
transaction.
Can buyer afford monthly payments on
both loans?
Does second have provisions that
make default likely?
21. Unencumbered Property
Contract for deed
Seller may choose to use a contract for deed
instead of mortgage or deed of trust. Also
known as:
land contract
bond for deed
conditional sales contract
installment sales contract
installment land contract
real estate contract
22. Contract for deed
How contract for deed works
Seller (vendor) keeps title to property until
buyer (vendee) pays off entire purchase price
in installments.
Legal title: vendor’s title during contract
term.
Equitable title: right of vendee to possess
and enjoy property.
23. Contract for deed
How contract for deed works
Contract:
not accompanied by promissory note
states all terms of sale and financing
arrangement between vendor and
vendee
should always be recorded
24. Contract for deed
Remedies for breach of contract
Forfeiture: penalty if vendee breaches
contract.
Vendee’s rights in property are
terminated.
Payments may be kept by vendor as
liquidated damages.
Vendor may retake possession of
property immediately.
25. Contract for deed
Remedies for breach of contract
In Texas, repossession not allowed
40% of the amount owed OR
has made 48 monthly payments
Trustee must be used to sell property
instead
26. Contract for deed
Remedies for breach of contract
Vendee refusing to leave means legal action
to clear title and remove vendee from
property.
Drawback for vendor: may take months.
27. Contract for deed
Remedies for breach of contract
Judge may:
enforce contract as written
give vendee time to pay off contract
balance
allow vendee to reinstate contract by
paying delinquent payments plus interest
order sheriff’s sale of property
28. Contract for deed
Advantages and disadvantages
Advantages for vendor:
legal owner until contract paid in full
may reacquire property in event of
default
29. Contract for deed
Advantages and disadvantages
Disadvantages for vendor:
delay and expense of court proceedings
uncertainty of trial results
31. Contract for deed
Advantages and disadvantages
Disadvantages for vendee:
vendor remains legal owner
judgments against vendor might cloud
interest
uncertainty of court decision
32. Contract for deed
Using a contract for deed
Lenders generally don’t permit financing to
vendees due to the nature of the ownership
Two possible solutions:
Vendor agrees to have property stand as
security for institutional loan.
Vendee could mortgage his equitable
interest in property.
33. Contract for deed
Using a contract for deed
Vendor agrees to have property stand as
security for institutional loan.
Vendor doesn’t assume personal
responsibility for repayment.
Lender can foreclose on property but
can’t sue vendor for deficiency.
34. Seller Financing as Primary Loan
Encumbered property
Seller of encumbered property can’t afford to
pay off existing mortgage at closing.
Seller second was one alternative.
Wraparound financing is another
alternative.
35. Encumbered Property
Wraparound financing
Wraparound financing:
property remains subject to underlying
loan
buyer does not assume underlying loan
seller remains responsible for payments
buyer makes monthly payments to seller
seller uses part of buyer’s payment to
make payment on underlying loan
36. Wraparound Financing
Choice of finance instrument
For wraparound, seller can use:
mortgage
deed of trust
contract for deed
Deed of trust used for wrap: all-inclusive trust
deed.
37. Wraparound Financing
Underlying loan: no due-on-sale clause
Wraparound financing is only proper if
underlying loan doesn’t have due-on-sale
clause and lender approves of it.
Silent wrap: without lender’s consent.
38. Wraparound Financing
Compared with assumption + second
If seller’s existing loan has no due-on-sale
clause, parties can choose between:
assumption plus seller second
buyer gets benefit of existing loan with
below-market interest rate
wraparound
may give buyer below-market rate and
seller above-market yield
39. Wraparound Financing
Seller’s yield
Seller’s yield depends on:
amount of credit extended to buyer, and
difference between interest rate on wrap
and rate on underlying loan.
Credit extended is:
difference between wrap amount and
balance on underlying loan
not full amount of wrap
40. Wraparound Financing
Seller’s yield
Example:
Sales price: $200,000 Downpayment: $20,000
Underlying loan: $150,000, balance at 6%
interest
Wraparound: $180,000 at 7.5% interest
$180,000 Wrap financing for buyer
– 150,000 Seller’s underlying loan balance
$30,000 Credit extended to buyer
41. Wraparound Financing
Seller’s yield
Example, cont.
In first year:
Seller collects $13,500 in interest from
buyer.
Seller pays $9,000 in interest on underlying
loan.
Net interest to seller: $4,500.
Net Interest ÷ Credit Extended = Seller’s Yield
$4,500 ÷ $30,000 = 15%
42. Wraparound Financing
Protecting wraparound buyer
To ensure seller makes payments on
underlying loan:
provision in finance instrument requiring
seller to make timely payments, and
allowing buyer to pay lender directly if
seller defaults
“Request for Notice of Delinquency”
escrow account managed by third party
43. Alternatives to Seller Financing
Seller can help with:
buydown
contribution to closing costs
equity exchange
lease/option
lease/purchase
44. Alternatives to Seller Financing
Buydowns
Buydown: seller pays to reduce buyer’s
interest rate on loan.
Seller proceeds are reduced by amount of
buydown.
Buyer more easily affords lower payment
and/or qualifies easier with lower DTI
45. Alternatives to Seller Financing
Contributions to closing costs
Seller sometimes willing to make up shortfall
when buyer doesn’t have enough money for
closing costs.
Lenders impose limits on amounts.
46. Alternatives to Seller Financing
Equity exchanges
Seller may be willing to accept other assets
from buyer and reduce cash sales price.
Equity in vacant land or personal
property.
47. Alternatives to Seller Financing
Lease arrangements
Sometimes buyer wants to lease home before
actually buying it.
Time to get cash for closing or
downpayment.
Cannot currently qualify for loan.
48. Alternatives to Seller Financing
Lease arrangements
Seller can lease property to prospective buyer
in one of two ways:
lease/option arrangement
lease/purchase arrangement
49. Lease Arrangements
Lease/options
Lease/Option: lease agreement includes
option to purchase.
Seller leases property to buyer for term.
Buyer granted option to purchase
property at certain price during lease
term.
Seller = Landlord/Optionor
Buyer = Tenant/Optionee
51. Lease/Options
How lease/option works
Lease/option:
buyer pays seller option money to make
option binding on seller
option money not refundable
option money may be applied to
purchase price if buyer exercises option
rental payments may be applied to
purchase (rent credit)
52. Lease/Options
Rental payments
Rent charged on lease/option is often higher
than rent under ordinary lease.
Gives optionee incentive to exercise
option quickly.
Provides compensation to optionor for
uncertainty of outcome.
Permits a lender at the exercise of the
option to credit excess toward down
payment.
53. Lease/Options
Rent credit
Three ways rent credit can be applied to
purchase:
applied to down payment
deducted from sales price
applied toward closing costs/prepaids
54. Lease/Options
Provisions of lease/option agreement
Lease/option should:
include all terms of lease
include all terms of potential purchase
contract
state that option money is not security deposit
state that option rights are forfeited if tenant
defaults on lease
state that option money is forfeited if
purchase is not consummated by buyer
55. Lease Arrangements
Lease/purchase
Lease/Purchase: purchase contract allows
buyer to lease property for extended period
before closing.
Parties sign purchase agreement (not
option) along with lease.
Tenant/buyer provides good faith deposit
instead of option money.
Closing date set quite far off; buyer rents
property in meantime.
56. Lease Arrangements
Lease/purchase
If tenant/buyer decides not to buy property,
good faith deposit is forfeited.
Tenant/buyer probably more committed
with lease/purchase contract than with
lease/option.
Eventual sale more likely.
57. Agent Responsibilities
Real estate agent should:
make sure both parties understand seller
financing arrangement
encourage both to consult lawyers or
CPAs
never prepare seller financing documents
58. Agent Responsibilities
Disclosures
Seller financing disclosure:
required in some states when agent
helps arrange seller financing
discloses all financing terms
informs seller of buyer’s financial
situation
59. Agent Responsibilities
Disclosures
Good idea to use disclosure statement even if
not required by state law.
Provides information to parties.
Protects agent by documenting that
certain information was provided.