Seller Financing: Definition, Method & Effects

Instructor: Ian Lord

Ian is a real estate investor, MBA, former health professions educator, and Air Force veteran.

In this lesson we will define seller financing and how it works. We will also address some of advantages and disadvantages of this creative financing method.

Seller Financing Definition

Did it ever occur to you that real estate can be bought and sold without involving banks? Sure, someone can always write a check and pay in full in cash. Crazy idea: what if money could be borrowed but without going to a traditional lender?

With seller financing the seller acts as the lender. But how does this work?

Seller Financing Methodology

So how is this different than a bank? The buyer and seller create a promissory note that outlines the terms of the loan. The terms are entirely negotiable. The note will contain the interest rate, the length of time the loan lasts, and the consequences for failure to pay. The buyer and seller record the mortgage with the local public records authorities as legal proof of the deal. Attorneys and real estate agents are helpful in making sure that the documentation is thorough, complete, and legally protects the interests of both parties.

The buyer usually makes a down payment on seller financing loans. The exact amount is up for negotiation. The term length is typically shorter than conventional financing. A bank is happy to loan money for thirty years. An individual seller will probably not want to have the loan out for that long. As with just about every detail in seller financing, negotiation on the specifics is possible.

The loan might have a balloon payment due at a certain point. For example, the buyer might make loan payments for five years, as if they had taken out a thirty-year loan, but then pay the complete outstanding balance at the end of five years or refinance. Another option is a large down payment and then a longer term loan the seller agrees to, say ten or fifteen years.

Seller Financing: Issues for the Seller

Before a seller can consider offering financing, they typically have to have any existing mortgages paid off. A traditional lender isn't going to want to have a loan outstanding on a property that the borrower doesn't own.

Why would anyone do seller financing? For one, it might help a seller conveniently sell a property. Say the property already has a renter who wants to buy the place. The seller could free up some equity and get access to that money while still collecting a monthly payment for a few years. Maybe the seller is retiring or moving away and would like some guaranteed cash flow without having to be a landlord.

Here are some other advantages for the seller:

  • Potentially higher interest rate than other investments
  • No waiting for a regular lender
  • Potential to sell the house as-is
  • The promissory note can be resold to another investor

A few of the cons for sellers include the following:

  • The house needs to be owned outright
  • Starting foreclosure proceedings if the buyer stops paying

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