When most people buy a home, they go through the traditional home-financing process: find a lender, submit proof of income and creditworthiness, jump through a whole bunch of hoops, and walk away in a month or two with a new loan.
The good news is there's another, bank-free way to buy a home: Seller financing.
What is Seller Financing?
Using seller financing to buy a home means the owner of the property, not the bank, agrees to lend money to the buyer during the home sale process.
The seller doesn't get the typical lump sum at sale, but instead receives mortgage payments over time. Generally, there are still some “traditional” loan aspects, like a down payment, but the rest of the process is left entirely up to the owner of the home and the buyer.
To those not familiar with seller financing, this can seem strange. In fact, when I refinanced my own home that I purchased using seller financing to a traditional mortgage, I needed to explain what it was to many of the lenders I spoke to!
However, although initially complicated, this approach can offer a path to home ownership (or home sale) that would be otherwise unattainable.
Before we do a deeper dive into how this process works, be aware that seller financing will also appear in listings or be referred to as:
- Owner Financing
- Owner Backed Mortgages
- Holding a note
- “Owner will carry”
- “Seller will carry”
- “Carrying a note”
At first glance, it seems like no seller would choose to carry a note for their buyer. After all, there are a number of downsides, including:
- No lump sum: When a home is sold, the mortgage that is currently on the house is due immediately. In a traditional situation, the buyer's mortgage will pay off any remaining principal on the house. In seller financing, there is no traditional buyer's mortgage, so the seller is responsible for paying off any remaining principal.
- Having to deal with collecting payment: Instead of being able to walk away from the property, cash in hand, owners have to deal with collecting monthly mortgage payments and making sure that the buyer doesn't default on the loan.
- Higher Risk: Like a bank, a seller takes on some amount of risk in seller financing. If the buyer cannot pay, they have to deal with foreclosing on the home.
But, seller financing can be great for sellers in a few different scenarios:
- Provides a sale opportunity for unusual houses: If a home isn't properly permitted or has other factors that make qualifying for a conventional mortgage difficult, seller financing might be the only way — besides cash — they could get the home taken off their hands.
- Spreading out the tax burden: Since the seller isn't getting a lump sum — aside from a possible down payment — the profit they make on their house can be spread out over multiple years.
- Selling the house quickly: There's no need to wait for mortgages to go through, so a seller-financed house can close incredibly quickly.
For buyers, there are a few downsides in this type of scenario, most notably:
- Higher Interest Rates: Sellers aren't governed by the free market, and can set interest rates that minimize the risk to them.
- Potential to be Predatory: Since no appraisal is required, uninformed buyers could end up overpaying for a home. To that end, NEVER purchase a home with seller financing without consulting a real estate agent, appraiser, or other home valuation expert.
Yet, there are also undeniable pros, which include:
- Not needing to be traditionally qualified: Since the seller is the lender, there's no need to meet the typical restrictions on credit score, income, or work history required to get a traditional mortgage.
- Less expensive: Without banks, you avoid many of the fees that come with the traditional mortgage process, which can be significant.
When buying a second home, you often have to pay higher interest rates and larger down payments than on a primary residence. However, there aren't the same hard-and-fast rules with seller financing.
Although seller-financed interest rates may be higher than primary residence rates, rates for a seller-financed investment property might be lower than a conventional mortgage rate.
In addition, if a seller is okay with a down payment below 20%, the buyer could hold on to the property and refinance into a conventional mortgage once they've built up a sufficient amount of equity.
It's for reasons like this that one of my good friends who manages several investment properties always asks the seller to finance the property. She's realized that securing seller financing can provide considerable savings and flexibility in getting property compared to conventional mortgage situations.
Seller Financing works differently in every situation, but traditionally, the process ends up going something like this:
- Buyer and seller decide on using seller financing
- Seller determines trustworthiness of buyer
- Property inspections
- Some sort of escrow process or time to negotiate contract
- Contract is finalized and signed
- House is handed over
Since these steps are often quite different from getting conventional home financing, I'll go into them in depth and give suggestions on ways to make the process as smooth as possible.
Negotiating the offer can be the hardest part of a seller-financed sale, largely because seller financing is rare and requires the seller to take on additional risk.
Because of this, the easiest way to purchase a property with seller financing is to search specifically for homes already offering it.
You can find a large number of seller-financed homes with some simple Googling. For example, when I search “seller financed homes for sale in California,” it returns all the listings in which the owner advertised that they would be willing to carry a note.
Still, buyers can always just ask an owner if they would be open to seller financing. To many — including myself before I got my seller-financed home — this can feel incredibly intimidating!
But, remember that you have nothing to lose in this scenario. The worst they can do is say no and you can either find a more traditional source of financing or simply move on.
After going through this process myself, I've noticed a few factors that may mean a seller is more likely to be okay with holding a note:
- The house is listed “For Sale By Owner” (FSBO): There is more room for person-to-person negotiation.
- You've developed a good relationship with the owner: The more the owner knows you, the more willing they may be to trust you with getting your payments in on time.
- It isn't the seller's only home: If someone is selling a rental property or second home, they're less likely to need the lump sum that comes with a traditional mortgage to purchase their next primary residence
In buyer qualification for seller-financing, anything goes. While buyers can most likely expect that the seller will ask to see a credit score or proof of employment, the process really is up to the seller.
Buyers will have the best chance of being approved by the seller if they are up front and willing to share as much information as possible.
Note: If you are the buyer, you should absolutely be evaluating the seller at this point too. Make sure the seller is someone you can work with over time, after all they'll be your home lender!
Like I mentioned before, sellers might be more willing to hold a note for you if you've developed a good relationship with them — or if they just like the idea of you occupying their home.
Although it sounds strange, I'm fairly certain one of the main reasons we were able to get seller financing for our first home is because we showed the seller how excited we were to take care of the property.
Once the buyers have met the seller's requirements for being offered seller financing, both parties need to work together to come up with a contract for the sale.
Similar to a contract that you would sign when you get a mortgage, this document will outline the down payment, interest rate, payment specifics, and other aspects that accompany the deal.
Unlike a standard mortgage payment, these specifics are not determined by the rules that govern standard real estate contracts.
As you may have noticed, nothing about seller financing is typical — but there are a few things that seem to be more common in seller financing contracts:
- Higher down payments: While nothing about seller financing stipulates this, often owners will ask for high-interest down payments to pay off whatever is left of their loan or to feel more comfortable acting as lender.
- Higher interest rates: Since a seller's money is locked up in a financing scenario, rather than available to be invested elsewhere, seller financing often comes with higher rates than a traditional mortgage.
- Balloon repayment: Sellers don't want to be tied to collecting home payments for 30 years! Because of this, contracts will often have a balloon repayment clause stating that in some predetermined amount of time, the full loan value will become immediately due. By or before this point, the buyer would have to find another loan, pay off the house some other way (in cash or selling) or lose the property.
Although I say that these are typical, remember that the terms of your contract can vary wildly depending on the property you are purchasing!
If the seller is choosing to carry a note because other types of mortgages aren't available for the home, it's possible that the buyer may get similar terms to those a typical mortgage might offer, simply because the seller wants to get money out of the property.
In my opinion, these types of deals may be awesome — or a warning that this property will be hard to sell down the line...
Do your research on all seller-financed homes to make sure that reselling them in the future will be relatively easy, if that's something you're interested in.
That said, whatever you choose to do, always have a lawyer look over any sort of contract before you sign it!
Although it may seem like a bummer to use escrow for a seller-financed deal, it's an important part of the process.
I'd recommend reaching out to escrow after you decide on seller financing and an offer is made. This way, there can be an official schedule for document signing and house transferral.
While most people may think of escrow simply as time to secure bank funding, remember that it's also the time to do inspections, set up home insurance, and make sure there are no issues with the title.
Therefore, although the escrow process could, theoretically, take almost no time to happen, it's important that this window is long enough to allow for these essentials.
Seller financing will be different for everyone, but I think it's valuable to hear about other's experiences to better understand what the process could be like.
My experience with seller financing started with stumbling upon the perfect house. It was a FSBO property, with a seller so close by he rode his bike over to show it to me.
I immediately loved it, had the money for a down payment saved, and a great credit score. But I was young (i.e., not a long job history) and in a new part-time position (substitute teaching).
Since I was familiar with the home buying process, I planned on having a co-signer until I established a longer job history. (I wouldn't recommend that by the way!)
However, after expressing interest in the house and having some initial purchasing conversations, the situation with my co-signer changed and I found myself un-lendable.
I was still trying to get a conventional loan when I spoke to an amazing mortgage consultant who told me about seller financing. She convinced me that I should at least ask the sellers about it — but, to be honest, I didn't want to.
Although we had met the sellers several times and had a good rapport, I thought they would judge me or think poorly of me for asking something that seemed so crazy. But I decided to float the question anyway and, much to my surprise, they said they'd be willing to do it.
I agreed to share a credit report and, in our previous conversations, I had convinced them that I was driven towards finding a full-time teaching position and that I managed my finances well.
All of these factors meant they trusted I would be able to fulfill the loan, a two year seller's note with balloon repayment.
Before I put in an offer, I consulted with a local real estate agent to make sure that the amount I planned on offering was in the ballpark range of what the house was actually worth. With this information, and a lot of internet research, I put in an official offer.
At this point, we entered into escrow. Because the main seller was a retired lawyer (and an upstanding person), he was adamant that my partner and I have a lawyer look over the paperwork to ensure there wasn't anything that put us in a bad situation.
In addition, we had all the typical home inspections, disclosures, and negotiation that happens in escrow. All in all, the biggest issue we faced was that the escrow company was unorganized in filing our paperwork, so we ended up getting our keys a day later than planned.
About 10 months later, I was in a full-time teaching position and was able to refinance into a conventional mortgage. Having both done this refinance — and another refinance for a better rate recently — I can confidently say that working with a traditional lender felt significantly more frustrating and opaque than working with our seller.
In a large regard, we got incredibly lucky. We had an upstanding seller, familiarity with real estate contracts, and were able to negotiate seller financing on a home that would 100% qualify for a traditional mortgage.
Not every process will go this smoothly, but the more the seller and buyer vet one another before deciding to move forward with seller financing, the better I think the process will go.
Remember that this trust needs to go both ways. As a buyer, you'll have to get your payment to the seller every month — and they'll be directly involved in the process when you refinance.
In all honesty, I would absolutely use seller-financing again if it fit my purchasing needs best. The one thing I will probably want to do in the future would be to try to negotiate a longer repayment term.
I'm a natural worrier, and thinking about needing to get a mortgage on a tight timeframe, when I was not qualified with one to start, caused a few moments of stress.
Seller financing done right can be a great opportunity to get people in homes — especially those in rural areas or places that are traditionally hard to fund with conventional mortgages.
In addition, as long as sellers are thorough in determining the ability of their buyers to pay, it can allow them to sell a property that otherwise would need work or have trouble being sold.
However, done poorly, seller financing can trap buyers into home purchases they can't afford, have them end up overpaying for a property, or result in them signing unrealistic terms.
Choosing to purchase a home via seller financing without the help of a lawyer or real estate agent's opinion is an incredibly risky decision .
Because homes don't have to be appraised to get the loan processed, buyers could end up paying too much on their home purchase. As such, seller financing can open the door to predatory behavior — particularly when novice or uninformed buyers are involved.
At the end of the day, there is nothing inherently good or bad about seller financing. Instead, it should be considered as one additional tool in your home buying and selling arsenal, whether you are a first-time home buyer or are looking to grow your investment portfolio.