Seller financing is an alternative lending arrangement where a home seller (rather than a traditional mortgage lender) provides financing for a homebuyer. At its best, this type of financing helps more prospective buyers become eligible homeowners — but it’s also not without risks.
Here’s what you need to know about owner financing before getting started.
Seller financing is a type of real estate transaction where a homebuyer enters into a financing arrangement directly with the seller, instead of borrowing a mortgage loan from a bank or another financial institution. It’s also known as “owner financing” or a “purchase-money mortgage.”
Overall, this process works fairly similarly to the traditional mortgage process , except the seller is responsible for managing the debt rather than a professional mortgage lender. The buyer still signs a purchase contract and promissory note , which legally obligates them to repay the loan.
However, because individuals aren’t subject to the same oversight as banks or credit unions, seller financing arrangements are often more flexible than traditional lending. For instance, the seller may not require as big of a down payment . They also may not charge the same closing costs that would be common from a mortgage lender.
As a result, these types of transactions can often be advantageous for those who have bad credit or may otherwise be unable to meet minimum mortgage requirements .
Have bad credit? Consider applying for a bad credit home loan to increase your chances of mortgage approval.
There are a few different types of seller financing arrangements to consider, including:
Lower closing costs. You don't have to cover bank fees and potentially don't have to pay home appraisal or home inspection fees.
Less availability. Not all sellers are willing or able to offer owner financing.
Faster closing. With fewer due diligence requirements, you can complete the sale quickly.
Positive investment return. In providing the loan, you'll receive the down payment and the monthly payment , with interest.
More risk. The buyer could default on the loan and damage the home, forcing you to initiate the foreclosure process and pay for any repairs.
Laws can be complex. Federal and state law can limit owner financing contracts and balloon loans as a matter of consumer financial protection.
Unfortunately, there’s no one-size-fits-all answer to whether seller financing is a good idea. If you decide you’re going this route, be sure to vet the other party in the transaction to ensure they’re trustworthy. It’s also wise to hire a real estate attorney to draw up the appropriate paperwork for you.
Owner financing may not affect your credit in the same way a traditional mortgage might, but it can still have an effect.
For example, if the seller decides not to report your payments to the credit bureaus, paying on time won’t help build your credit score and missing a payment here or there won’t harm it either. However, if you decide to stop making payments on your mortgage and default on the loan , the seller can take you to court and file a judgment against you, which will negatively impact your score.
Typically, a seller financing arrangement will allow the buyer to make a series of regular installment payments on the loan for a set period of time before requiring a balloon payment. A balloon payment is a large, lump-sum payment that repays the loan in full. The buyer may need to save up for this payment or apply for a refinance when it becomes due.