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   ARTICLE   |   From Scotsman Guide Residential Edition   |   November 2007

Getting Creative With Seller Financing

Knowing two options can help deals close easily

There are two areas where mortgage originators can make money with seller financing:

  • When it is used as a second mortgage behind an institutional first mortgage.
  • When it is used to refinance the seller-held first mortgage to “cash out” the seller.

Let’s look at each in turn.

Second behind institutional first

This scenario could work when brokers have no other option for their borrowers; and it still can help brokers gain commission.

Borrowers might qualify for a first mortgage with an 80-percent loan-to-value (LTV) but might not have the 20-percent downpayment in cash. A Federal Housing Administration (FHA) mortgage or mortgage insurance might work.

If not, would sellers take a second mortgage to bridge the difference between the first mortgage plus available downpayment and the total purchase price?

The sellers’ answer may be yes, especially if they are sitting on a decent profit on the property. Sellers have a different motivation than a lender might. If the lender doesn’t make the deal, it loses only the 7-percent or 8-percent interest it would have made on the loan. The sellers lose the entire sale and the profit they would have made on it.

If it is an investment property for sale, rather than a prime residence, the sellers also have the advantage of a tax deferment on the amount of the sellers’ mortgage. This scenario also provides a constant cash flow to the sellers, along with the interest they are charging. This interest rate can be higher than they could have received by putting the extra proceeds in a bank certificate of deposit (CD).

The sellers are taking a risk of their second mortgage not being paid, however. For this reason, it’s not often wise to offer a seller-held second mortgage to create a “no money down” deal, especially to someone with poor credit.

Refinance a seller-held first

A purchase-money mortgage usually requires a downpayment. But downpayments are not required when people refinance.

Seller financing is often involved in selling lower-value properties to people with poor credit or little credit history. Provided the seller, now the note-owner, can prove receipt of monthly payments on time, the borrower can show a track record for timely payments.

This technique is used by many real estate investors who buy houses cheap, fix them up and sell them at a profit — but cannot qualify the homebuyers for an institutional mortgage.

These investors will give seller financing for a few years, often at a high interest rate or with a short-term balloon. Predatory-lending laws do apply here, as well.

By the time that you as a broker are aware of the loan, it has often been seasoned for several years. There should have been some pay down of principal and hopefully some appreciation in the property value.

There also is an option to sell properties on an “agreement for deed,” sometimes called a “contract for deed,” rather than giving the borrower a standard mortgage.

 


 


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