Disadvantages to Owner Financing

What’s old is new again and the economic impacts of COVID-19, resulting recession, and tightening lender requirements are making seller financing the come back kid of 2020.

There are many reasons to offer seller financing when selling a property. Seller financing can attract more buyers and even save transactions as banks increasingly deny potential home-buyers on mortgage applications. You may have considered owner financing before, but before you agree to “Be the Bank”, it’s worth carefully considering the potential downsides to providing creative financing.

Time is Money

For most sellers waiting to get paid each month is the biggest drawback to using seller financing since they would originaly have prefered to receive the full purchase price in cash at closing. If a long sting of payments over 10, 20, or 30 years creates issues for you as a seller, consider using a balloon payment to shorten the term of repayment. A balloon payment (and higher interest rate) can also incentivize a borrower to seek our conventional financing and get you cashed out sooner.  Using temporary seller financing techniques can also help optimize a subsequent sale of the payments to a note investor.

Honey, Did You See That Check?

Part of the seller’s responsibility when using seller financing is keeping track of each payment and keeping detailed records. This takes time every month to ensure the proper amounts of each payment are correctly attributed to principal and interest. An amortization schedule helps to accurately calculate the interest, principal, and remaining balance due. Accurate and organized records can also make it easier to sell your note in the future. Beyond accurate record keeping, when you use seller financing, there are annual 1098 mortgage interest statements to prepare. If this all sounds like more than you bargained for, don’t worry. Many sellers decide to leave all this to a professional and make use of an outside servicer.

Here Comes Guido

Hate asking people for money? Well when your seller finance payments don’t arrive on time, sellers will quickly find they are now the bill collector. They also have to worry about if the buyer maintains the property, lets the property insurance lapse, fails to keeps the real estate taxes current, or violates any other terms of the financing arrangement.

Property Value Risk

There is the risk a seller will need to initiate foreclosure proceedings if the buyer fails to make payments (or follow any other terms of the note).  Along with time and money, in today’s market foreclosure comes with the risk a property might be worth less than the outstanding balance due.

Who’s On First?

When a property is sold with owner financing and the seller still owes money both the buyer and seller need to be concerned about timely repayment of the underlying lien.  The first position might also have the right to accelerate their mortgage under some type of due on sale clause. Most note investors will pay off the seller’s underlying liens out of proceeds when they purchase the future payments

They Offered How Much?!

If a seller gets tired of the monthly payments trickling in they can sell the note to an investor for cash now. While future payments can be sold to a note investor, it is almost always at a discount rather than full face value (also called ‘par value‘). How steep of a discount depends on the equity, interest rate, payer credit, property type, and other terms.

Of course it’s not all bad.

Many buyers and sellers use owner financing to create a winning solution for both sides.  The trick is to work with qualified professionals that can steer you in the right direction. To discover the positive side of seller financing be sure to read 10 Advantages to Using the Seller Carry Back.