Seller financing can be a helpful tool in a tight credit market. It lets sellers move a home quicker and get a sizeable return on the investment. And buyers may benefit from less stringent qualitying and down payment requirements, more flexible rates, and better loan terms on a home that otherwise might be out of reach.

The Mechanics of Seller Financing

In seller financing, the seller takes on the role of the lender. Instead of paying the buyer, the seller extends enough credit to the buyer for the purchase price of the property, minus any down payment. Both the buyer and seller sign a promissory note (which contains the loan terms). They record a mortgage (or "deed of trust") with the local public records authority. Then the buyer pays back the loan over time, usually with interest.

Types of Seller Financing Arrangements

• All-inclusive mortage — In an all-inclusive mortage, the seller carries the promissory note and mortgage for the entire balance of the property price, minus any down payment.
• Junior mortage — In today's market, lenders are reluctant to finance more than 80% of a home's value. Sellers can potentially extend credit to buyers to make up the difference. The seller can carry a second mortage for the balance of the purchase price, minus any down payment. In this case, the seller immediately gets the proceeds from the first mortgage from the buyer's first mortgage lender. However, there is a seller's risk in carrying a second mortgage. He or she accepts a lower priority should the borrower default. In repossession, the seller's second mortgage is paid only after the first mortgage lender is paid off and only if there are sufficient proceeds from the sale. Moreover, the bank may not agree to make a loan to someone carrying so much debt.
• Land contract — Land contracts don't pass title to the buyer, but give the buyer "equitable title," a temporarily shared ownership. The buyer makes payments to the seller and, after the final payment, the buyer gets the deed.
• Lease option — The seller leases the property to the buyer for a contracted term, like an ordinary rental — except that the seller also agrees, in return for an upfront fee, to sell the property to the buyer within some specified time in the future, at agreeable terms.
• Assumable mortgage — Assumable mortgages lets the buyer take the seller's place on the existing mortgage. Some FHA and VA loans, as well as conventional adjustable mortgage rate loans, are assumable — with the bank's approval.

It is adviced that both the buyer and seller get an attorney or a real estate agent or some other qualified professial experienced in seller financing and home transactions to write up the contract for the sale of the property, promissory note, and any other necessary paperwork.

Additionally, reporting and paying taxes on the seller-financed deal can be complicated. The seller may need a financial or tax expert to provide advice and assistance.

Tips on Reducing the Seller's Risk

• Require a loan application — The seller should insist that the buyer complete a detailed loan application form, and thoroughly verify all the information the provides there, including running a credit check and vetting employment, assets, financial claims, references, and other background information and documentation.
• Allow for seller approval of the buyer's finances — The written sales contract, specifying the terms of the deal along with the loan amount, interest rate, and term, should be made contingent upon the seller's approval of the buyer's financial situation.
• Secure loan by home the property — The loan should be secured by the property so the seller can foreclose if the buyer defaults. The home should be properly appraised at to confirm that its value is equal to or hiehger than the purchase price.
• Get a down payment — Institutional lenders ask for down payments to give themselves a cushion against the risk of losing the investment. It also gives the buyer a stake in the property and makes them less likely to walk away at the first sign of financial trouble. Sellers should do likewise and collect at least 10% of the purchase price. Otherwise, in a soft and falling market, foreclosure could leave the seller with the home that can't be sold to cover all the costs.

Negotiating the Loan

As with a conventional mortgage, seller financing is negotiable. To come up with an interest rate, compare current rates that are not specific to individual lenders.

Because sellers typically don't charge buyers points (each point is 1% of the loan amount), commissions, yield spread premiums, or other mortgage costs, they often can afford to give a buyer a better financing deal than the bank. They can also offer less stringent qualifying criteria and down payment allowances.

However, that doesn't mean the seller must or should bow to a buyer's every whim. The seller also has a right to decent return. A favorable mortgage that comes with few costs and lower monthly payments should translate into a fair market value for the home.

Hiring a Loan Servicing Company

To help ease the paperwork burden, sellers can hire a loan servicing company to help draw up the mortgage, mail statements to the buyers, collect payments, and otherwise administer the mortgage.