Seller financed Investment properties are great opportunities for investors to expand their real estate portfolio without using traditional lending. Seller financed deals are exactly what they sound like: The seller, instead of a traditional bank, provides the financing to the purchaser, usually with a secured mortgage on the property being purchased. Seller financed deals can be a good way for an investor to do a deal even though s/he does not qualify for a traditional mortgage. While seller financed deals can be advantageous for investors, there are a number of things to know. Below are five points every investor should know before getting involved in a seller financed deal.
All Terms Are Negotiable in Seller Financed Deals.
Since you are dealing with an individual or a small company and not a traditional bank, you are free to negotiate any term of the seller financing documents. This is much different than a real estate transaction with a traditional bank where you have very little leverage to change the terms (e.g. interest rate, term, amount of financing, etc.). You can ask for one hundred percent financing in exchange for a shorter term or higher interest rate, and you may even negotiate more specific items such as the cure period in the event of default. Some sellers will be open to negotiations while others may not. However, often times a seller may insist on less favorable terms than a traditional bank understanding that some purchasers may not be able to obtain traditional financing. The takeaway is that seller financed deals are very different from deals with a traditional bank and any term of the mortgage or promissory note is potentially negotiable.
Seller Financed Deals May Move a Lot Faster.
A seller financed deal may move a lot faster than a deal involving traditional bank financing. This is because you do not have to wait for the bank to go through a long checklist of items before it will provide the clear to close. With seller financing, a seller will typically have a due diligence period to investigate the financial wherewithal of the purchaser. If the seller finds the purchaser’s financial wherewithal acceptable, a closing can be scheduled soon, and the attorneys will simply draft the mortgage and promissory note (and any other documents agreed upon). This timeline is potentially much faster than using a traditional bank. Therefore, one of many advantages of a seller financed deal is that such deals are streamlined and can close a lot faster than deals with traditional bank financing.
Think Carefully About Seller Financed Deals If There Are Other Mortgages on the Title.
If you are contemplating a seller financed deal, it is important to review a title search of the property to determine whether there are other existing mortgages on title. If there are mortgages already on the property, and you are taking title subject to existing mortgages, there is heightened risk to doing a seller financed deal. The seller financing may violate the due on sale clause on any existing mortgages. Moreover, mortgages may provide that you cannot further mortgage out the property without the bank’s permission. Therefore, there is a risk that a seller financed deal subject to an existing mortgage can trigger a default on the existing mortgage. A seller financed deal is ill-advised when there are other mortgages on the property, unless these banks consent to the transaction.
Moreover, from a seller’s standpoint, even if the other banks did consent to the seller financing subject to existing mortgages, a seller may not be secure in the event a foreclosure is necessary. In other words, the balance on the existing mortgages may be high enough so that a foreclosure on the Seller’s mortgage may not satisfy the seller’s loan. There are therefore concerns from both the seller’s and buyer’s perspective on a seller financed deal if there are existing mortgages on the title. Many investors believe seller financed deals with other mortgages on title are not worth the risks. However, other investors may have a higher risk tolerance.
The Note May Be Sold As With Any Deal Involving a Traditional Bank.
As with a traditional bank, the promissory note can be sold to another entity. The fact that seller financing was used in the deal does not mean that the seller is prohibited from then selling the note either to another individual, bank, or company. Therefore, do not be surprised if you receive a notice one day that your note has been sold and you will now make payments to a different entity.
Make Sure the Contract Accounts for the Terms of the Seller Financing so There are No Surprises.
Every investor should know that if the seller agrees to provide seller financing, you should not wait until a few days before the closing to discuss the terms of the financing. It is important to discuss the terms of the financing even before you sign the contract. This way, you can, and should, include provisions in the contract that specify the material terms (e.g. interest rate, term, balloon payments, prepayment penalty, etc.) so there is no misunderstanding when the financing documents are being drafted by the lawyers.
In summary, seller financed deals are great opportunities. Keep the above items in mind, and you will be better prepared to negotiate and close a seller financed deal without any issues.