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   ARTICLE   |   From Scotsman Guide Residential Edition   |   October 2008

Seal the Deal with Seller Financing

Knowing how to facilitate a seller-financed transaction can help brokers earn trust and referrals

When clients don’t qualify for a traditional mortgage, assisting them with a seller-financing transaction can give mortgage brokers an opportunity to develop future business with the buyer, the seller and the real estate agents.

When helping clients with seller financing, brokers should facilitate a transaction to earn future business rather than trying to earn fees from these deals. Although you could charge a fee, you open yourself to potential legal and liability issues and undermine the rest of your efforts. As soon as you start a sales pitch, you lose trust and become just another mortgage broker.

Instead, focus on helping your clients and partners to establish your credibility. Educate clients about how seller financing can help and show them how to implement it correctly.

Taking this approach, you can earn a prospect’s loyalty and establish yourself as a reliable resource.

Benefits

When it comes to seller financing, the biggest benefit to sellers and buyers alike is that a transaction that would not otherwise occur closes -- the sellers can sell their property, and the buyers can buy a property. There are other benefits specific to each party.

  • Buyers will usually spend less on closing costs and can secure flexible financing that meets their needs without the strict requirements of conforming loans. An attractive interest rate for the seller is not as high as it seems when buyers account for the lower closing costs and the cost of waiting to buy a property for another one or two years.
  • Sellers often can increase the number of buyers interested in their property and will often sell the property closer to their asking price. Also, they can receive a higher interest rate than they may obtain with other investments like money-market accounts, stocks and bonds. Also, sellers often can create a tax shelter to reduce their taxes while creating a monthly income stream and eliminate monthly payments for taxes, insurance, utilities and maintenance.

Types of seller financing

There are a few different methods of seller financing. They include contracts for deeds, mortgages and loan assumptions.

A contract for deed -- also known as a land contract, contract for real estate and real estate contract -- generally is simple, easy to create and relatively easy to terminate. This is an agreement to transfer ownership of property between a seller (the vendor) and buyer (the vendee). It is essentially a purchase contract that takes years to close instead of 30 to 60 days. The buyer pays the seller a downpayment and monthly payments. If the buyer meets the agreement’s requirements, the seller then gives the buyer the deed to the property. If the buyer does not pay as agreed or does not meet other requirements of the agreement, the seller can retake the property and sue the buyer. The seller stays in title while the buyer gains equitable interest in the property.

Seller financing with a mortgage is like a regular purchase transaction except that the seller is also the lender. The buyer receives the property deed at closing and signs a promissory note and mortgage, which provides the seller with the note receivable and lien on the property to enforce the promise to pay. When the buyer pays the debt in full, the seller releases the lien and the buyer has clear title to the property. The mortgage can be a single first loan or a second loan with traditional financing. Foreclosure of a seller-financed mortgage is the same as a standard foreclosure.

Finally, loan assumptions may see renewed interest as rates and lending requirements increase, but they are not viable options for several reasons. First, because conventional loans no longer allow assumptions, fewer loans are even possible options. Nearly all loan assumptions require a buyer to qualify for the loan with standard underwriting guidelines. Although any buyer, without requirements, can assume Federal Housing Administration loans closed before Dec. 14, 1989, and U.S. Department of Veterans Affairs loans closed before March 1, 1988, sellers remain legally responsible for the mortgage in the event the buyer does not pay, unless the seller receives a release of liability. The lender will only issue a release of liability if the buyer qualifies for the loan, however. After all of this, the loan amount is likely so small the assumption will not save the buyer much money and will require too much downpayment, unless the seller offers financing.

It takes a team

Clients should discuss their situation with several professionals in addition to their real estate agent. First, they should identify and contact the title company they plan to use for the transaction. The title company can highlight any specific state or local requirements, provide estimates for fees, and offer referrals for escrow and legal services.

Next, clients should contact escrow companies to compare services and fees, and to determine if they can access their account via the Internet. Escrow companies can also provide referrals to a real estate attorney.

Clients also must contact an attorney regarding seller financing. At a minimum, they should address the following:

  • Contract for deed versus mortgage
  • Specific state and local laws, including usury limits
  • How to structure financing
  • Methods for contract termination and foreclosure
  • Differences between land and improved property
  • Eviction and tenant issues
  • What to include in the financing documents

Finally, clients should contact a certified public accountant (CPA) to determine the tax implications of seller financing. They should address when they will realize a gain or income, the difference between interest income and capital gains, and different options to minimize taxes.

Structuring the financing

The best way to structure seller financing is to mimic traditional lending. Doing so uses industry standards that protect the buyer and seller in a manner that most people understand.

The standard conforming-loan process, promissory note and deed of trust should be the basis for all seller financing.

For the loan framework, you will need at least the following:

  • Escrow company: This party makes payments to a servicing company that can verify payments in the event of a dispute or for either the buyer or seller when qualifying for a new loan. The escrow company should also maintain copies of all financing documents.
  • Insurance: The buyer must maintain hazard and flood insurance as applicable, naming both the buyer and seller as insured on any property with improvements.
  • Escrow account: Establish an escrow account for all tax and insurance payments.
  • Title policies: The seller should provide an owner’s title policy to the buyer, and the buyer should provide a lender’s title policy to the seller.
  • Survey: To identify any encroachments.
  • Recordings: The title or escrow company will record the mortgage or memorandum of contract and won’t forget to record the release of lien when the financing is paid in full.

Also, you will need to determine the financing terms, including an acceleration clause, due-on-sale clause, the power-of-sale clause and giving of notices.

Finally, negotiable-but-required terms include the:

  • Downpayment;
  • Interest rate;
  • Amortization;
  • Time and place of payments;
  • Late charges; and
  • Right to prepay defined.

If sellers are uncomfortable with the above requirements, simply ask them to compare the proposed process to when they got their previous mortgage and have them review the promissory note and deed. They likely have or have had a loan with these exact terms that they can review. Sellers typically feel much more secure knowing the process and terms are almost identical to “normal” loans. The difference is that with seller financing, they can be more flexible with the negotiable aspects and determine the minimum credit scores, credit history and assets they will accept as evidence of a qualified buyer.

Paying it off

There are many possible exit strategies for seller financing. The buyer and seller may choose to keep the loan long-term as an annuity for the seller and as advantageous financing for the buyer. The buyer can simply pay off the loan over time or with a balloon payment. The seller also can sell the loan to an investor.

Usually, however, buyers replace the seller financing with a new loan when they can qualify for conventional financing at a lower rate or when the seller-financing terms dictate.

Many private individuals and companies buy seller financing. The loan’s terms do not change for the buyer. The only change is that the owner of the contract or mortgage changes. Many factors determine the loan’s value, including payment history, interest rate, loan-to-value ratio, the buyer’s credit history and interest rates at the time of the loan sale. Sellers should consult with their CPA regarding the value of the debt and any resulting tax implications.

Underwriting payoffs of seller financing are similar to traditional underwriting. Lenders typically treat seller-financing payoffs as a purchase, a refinance or a cash-out transaction, depending on the situation. Although seller-financed mortgages must have a 12-month history, Fannie Mae and Freddie Mac have different requirements for land-contract refinances. Lending guidelines continue to change, so you must stay informed.

Otherwise, the new loan process is nearly identical to a regular refinance transaction. The escrow company provides copies of the documents, a verification of mortgage and the payoffs just as any other lender would do.

•  •  •

When proposing a seller-financing deal, don’t simply ask if the seller would be open to it. Instead, create a specific proposal that explains the financing structure and benefits, that mimics the conforming-loan process, and that contains terms and conditions similar to standard financing. Your plan is as much a sales pitch to the seller as it is a checklist for the buyer. As a result, you’ll have a successful transaction for everyone and future business opportunities for you. 


 


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