A few years ago my friend Carl’s aging grandmother needed to live in a facility that could care for her medical needs. Problem was, she didn’t have enough quite enough in her retirement account for the kind of high-quality place Carl’s family wanted.
The family’s solution? Sell grandma’s house.
Then they ran into another problem.
While the house was in a great neighborhood, grandma’s health problems meant maintenance on the house had fallen behind. The family was willing to lower the price to help account for the repairs, but unfortunately since the house couldn’t pass an inspection, many would-be borrowers couldn’t get a mortgage on it.
It just so happened that around the same time Carl was also looking to buy a house, but didn’t have a strong credit score. And then the idea came: Carl could buy the house from grandma using a private mortgage.
So, what’s a private mortgage?
In a private mortgage, the seller of the house serves as the bank in the home purchasing. The seller and buyer draft a private mortgage note without a traditional financial institution being involved. This process of establishing a private mortgage note is called “seller financing.”
In Carl’s case, Carl’s mortgage payments now each month go to his grandmother. She collects the payments and including the interest on Carl’s mortgage. Technically, if Carl doesn’t pay, his grandmother has the right to foreclose on the property. (Although, it’s hard to imagine a sweet grandmother foreclosing.)
Once Carl establishes a good history of making payments, his grandmother even has the option of selling this note to a note buying company to receive one payout.
Do we have to be related?
While seller financing is a popular option for families selling properties to one another, plenty of people who aren’t related use seller financing.
In a mortgage note between strangers, sellers tend to create mortgage notes with shorter terms. A traditional mortgage might have a 30 year term, but a private mortgage note might have a 5 year term with a balloon on the end. A balloon note is when the remaining balance on the loan is due all at once at the end of the term, typically motivating the buyer to refinance with a traditional lender before that time comes.
Like in Carl’s case, it can be a great way to sell a property that’s proven hard to sell, because it opens it up to be purchased by a larger pool of people. Still, the practice of seller financing is relatively uncommon is because most people sell their house with the intention of putting that money towards another house.
What’s in it for the home buyer?
Seller financing is a great way for would-be-homeowners to secure a home loan.
The biggest draw for buyers is that someone with a lower credit score who couldn’t qualify for a traditional mortgage actually has a shot with seller financing. It could mean a higher interest rate, but still some sellers can be negotiated with to offer financing to someone who otherwise would have had no other means.
In other situations, some people have great credit but hard-to-prove income. Seller financing also helps people who have unique income situations, like someone who just started their own business. This also goes for those with high amounts of tipped, freelance or commission income that can be hard to prove to traditional banks.
Why would the seller choose to be a financer?
Usually a home-owner uses seller financing to sell either a hard or impossible to sell property.
One of the most common types of traditional mortgages is an FHA loan. With these loans come regulations on the condition of the property. If a home isn’t up to FHA standards, a potential buyer can’t finance it with an FHA loan.
It can also be a matter of time and money. Closing a private mortgage takes about half the time as a traditional one. And since the seller is setting the interest rate, they may be able to get a higher return on the interest on the loan than other types of investments.
So whether or not you’re someone with a unique family situation or you have a credit score on the mend, now you know that seller financing is an option.
