Seller Financing

What is Seller Financing?

In very general terms, seller financing can be described as a loan provided by a seller to a buyer. In real estate, seller financing is also called “owner financing” or “bond-for-title.” In such cases, the buyer signs a mortgage agreement with the seller, and the seller handles the process. Such a practice eliminates the need for a financial intermediary to handle the process.

How Seller Financing Works

Normally, a seller financing arrangement involves having the potential buyer of a property or business make a down payment to the seller. As with other financing arrangements, seller financing also involves requiring the buyer to make monthly payments or installments (the time period may vary depending on agreed-upon terms) to the seller at an agreed-upon interest rate. The payments from the buyer to the seller will be ongoing until the loan is completely paid off.

In seller financing agreements, the seller basically offers the buyer an alternative to bank financing. Such an arrangement works well for the seller because it can be viewed as an investment with guaranteed returns (depending on the creditworthiness of the buyer and his/her motives to ensure they commit to the payments).

The benefit for the buyer is that he or she might not be able to qualify for a loan but is now able to purchase their intended property through an agreement with the seller. Furthermore, in the case where the buyer should default on payments, the seller can foreclose on or repossess the asset. The asset or assets being sold are usually used as security for the loan.

Advantages of Seller Financing

There are many benefits that come with being in a seller financing arrangement. Both the seller and buyer can save money when it comes to closing costs, including lawyer costs, taxes and stamp duties, interest expenses, etc. Another benefit that comes with seller financing arrangements is the ability for both parties to negotiate the repayment schedules, the interest rates, and other terms and conditions of the loan.

In cases where the asset in question is a house or residential property, the buyer is usually given the option to negotiate certain inclusions or conditions at the seller’s discretion. The buyer does not need to qualify for a loan with a financial institution. Moreover, the seller can receive a higher return on the “investment” through receiving equity with added interest. The seller can also negotiate a higher interest rate or higher selling price.

Furthermore, the property or asset being sold can be sold as-is, without additional upgrades or repairs. The seller (at his or her discretion) can select which security documents to keep for the purpose of protecting his or her interests until the loan is fully paid off.

Finally, another benefit can be that the seller can spread the capital gains made on the sale of the property over multiple time periods. It can minimize tax burdens, as the transaction is converted to an installment of sales.

Potential Challenges in Seller Financing Arrangements

As with many other arrangements, seller financing also comes with potential drawbacks. One example can be that a buyer has made all installments and paid off the loan, but not have the title transferred over to them due to unforeseen circumstances or encumbrances not known or disclosed by the seller. In cases where the seller may have secured a senior financing arrangement for the asset in question and despite the buyer making all payments to the seller, the property could undergo foreclosure due to the seller not having met his or her own financial obligations for the property.

Another drawback for a buyer can be that, in most cases, he or she is not able to afford property appraisal fees or inspections to ensure that he or she is really purchasing the property at an inflated price. In addition, a seller may not have all the relevant information pertaining to the buyer’s financial situation or full credit record. It can prove to be risky and likely lead to a foreclosure. Foreclosures can take close to 12 months to be finalized, depending on the type of security instrument that was utilized.

Finally, another challenge can be that a buyer commits to a down payment, but still abandons the property or asset because he or she would not have lost a tremendous amount of money. It would put the seller back at the beginning in terms of connecting with a new and trustworthy buyer.

More Resources

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

In order to help you become a world-class financial analyst and advance your career to your fullest potential, the following resources will be very helpful:

• Amortization
• Installment Loan
• Refinanced Mortgage
• Vendor Financing
• See all commercial lending resources