Your Mortgage; Creative Financing Can Benefit Both Home Buyers and Sellers

LA Times – Dec 3, 1995 – DIAN HYMER

Most people who buy a house use a new mortgage from a third-party lending institution such as a bank or savings and loan. Any financing arrangement that deviates from this is called “creative financing.” The most popular form of creative financing is seller, or owner carry-back, financing.

One benefit buyers find with seller financing is that the red tape of qualifying for a new conventional loan is bypassed. Seller financing also usually carries a lower interest rate and no points. Sellers will want to check the buyer’s credit history and financial statement, but the cumbersome loan qualification procedures required by a conventional lender is avoided.

There are also benefits to sellers, not the least of which is assisting in making a sale possible. Sellers can also derive tax benefits, if they would otherwise owe capital gains tax when they sell. Sellers who carry financing for buyers may be able to qualify for installment sale tax treatment with the IRS. An installment sale permits sellers to spread their tax liability over several years.

For some sellers, carrying financing for a buyer is a good investment that offers a higher rate of investment return than might be available elsewhere. Another benefit to the sellers is that they know the property against which the loan will be secured.

Seller financing may carry a stiff price, however. Some sellers who agree to carry financing will only do so in exchange for a higher price for their house. This may be worth it if it enables a purchase that would otherwise not take place. But overpaying in a market where prices are declining is unwise.

Negotiating a seller-financing agreement can be complicated. There’s more to it than simply agreeing on the loan amount and the interest rate. Other negotiable factors include: the term of the loan (when it’s due), the amount of the monthly payment (interest-only or amortized), the amount of the late-payment fee, whether or not the loan is due when the property is sold, and whether or not the loan will have a prepayment penalty. You may want to hire a real estate attorney to help you negotiate the terms of the seller carry loan, unless you have an agent who can help you.

Since most sellers aren’t in a position to carry a loan for 30 years, most seller financing loans have a balloon payment. A balloon payment is a large final payment, larger than the periodic (monthly) payments, which pays the loan off in full. Make sure that the term of your loan is long enough so that you don’t get caught owing a large balloon payment before you’re able to pay it.

First-Time Tip: 80-10-10 financing is popular among first-time buyers and trade-up buyers who need 90% financing to buy a house. If the sellers carry a second loan for 10% of the purchase price, and the buyers get an 80% first mortgage, the lender usually won’t charge the borrower for mortgage insurance.

Sellers usually advertise the fact that they’re willing to carry financing. But you may be able to uncover good candidates for owner-carry financing among sellers who aren’t actively offering creative financing. Likely candidates are seniors who are retiring and who don’t need all their cash at close, and sellers with sufficient equity who have been unable to sell for a long time and who don’t need their equity to buy another house.

The Closing: Owner carry-back sellers usually need to have enough cash left from the sale of their house, after their mortgagors and fees are paid, to make a loan.

Distributed by Inman News Features. For a copy of Dian Hymer’s brochure “Finding and Buying a House,” send $4 along with a self-addressed-stamped envelope to: Inman News Features–HOUSE, 5335 College Ave., Suite 25, Oakland, Calif. 94618.