Seller Financing in Real Estate Transactions: A Seller’s Options when the Buyer Cannot Obtain a Conventional Mortgage
What is Seller Financing?
Seller financing is an alternative method for the purchase of real estate where the seller of the property provides the buyer with financing, usually by way of express terms, rates, and conditions for purchase of the property. Instead of using a bank, other private lender, or mortgage originator, the seller finances the purchase price of the property. Seller financing is generally used when a homebuyer is unable to secure traditional financing for the purchase of real estate. There are three ways to offer a seller financing deal: (1) a wrap-around mortgage, (2) an installment land contract, or (3) a lease to purchase arrangement.
What are Wrap-Around Mortgages?
A wrap-around mortgage, commonly referred to as a ‘wrap loan,’ is when a homeowner who has a pre-existing mortgage on their property extends a junior mortgage to a buyer that is then “wrapped around” the seller’s pre-existing mortgage. In this situation, the seller takes on the role of the lender. The buyer and seller agree to a down payment and loan amount, sign a promissory note that lays out the terms of the mortgage, and then the title and deed pass on to the buyer. The buyer will then make monthly payments directly to the seller, often at a higher interest rate than the original mortgage (allowing for the seller to make a profit). It is important to understand that the buyer is not assuming responsibility for the homeowner’s pre-existing mortgage on the property—the seller retains this.
A seller should know the terms of their pre-existing mortgage before engaging in a wrap-around mortgage. Many mortgages contain ‘due-on-sale’ clauses, however, banks generally do not exercise this right if payments are still being made. Buyers should know the wrap-around is junior to the original mortgage. This presents risks for the buyer, but the proper arrangement can help avoid any issues and presents an opportunity to obtain otherwise unobtainable financing
What is an Installment Land Contract?
A wraparound installment land contract (aka “contract for deed”) is the same as a wraparound mortgage except the title remains in the seller’s name until the debt is paid in full. However, the buyer assumes possession of the property and the rights and responsibilities of ownership. Typically, the seller signs a deed that is placed in escrow with a title company to ensure that the buyer will get title if the seller disappears.
Upon default of the land contract, the legal process for the seller getting the property back is unclear under Colorado law. The court could allow a forfeiture of equity and permit an eviction by the seller, or the court could require a judicial foreclosure (sometimes a long and expensive process).The court’s decision is based on equitable factors, what is fair in the situation considering the buyer’s equity (size of down payment, accumulated equity, improvements, etc.).
What is a Lease to Purchase?
The third seller financing option is a lease to purchase. Some contract lease agreements provide the buyer with the option to purchase the home at the termination of the lease while others require the purchase. A prospective home buyer should understand the agreement they sign. In these arrangements, the buyer pays the seller a one-time, usually nonrefundable, upfront fee called the option fee, option money, or option consideration. This fee is what gives the buyer the option to buy the house by some date in the future. The option fee is often negotiable. The purchase price can be agreed upon when entering the lease or prior to the sale.
Seller financing may be a good, or sometimes the only, option available to buyers and sellers of real estate. There are many areas open for negotiation to secure your rights under the terms of a seller financing agreement. In addition, real estate rules vary by state. It is important to consult with an experienced real estate attorney to draft a seller financing agreement in order to include appropriate terms and to be able to enforce a forfeiture action, if needed by the seller. GLO has extensive experience in seller financing options all along the Front Range. If you need help drafting, enforcing, or defending a seller financing agreement, or have any questions about seller financing options, fill out an interest form today to see if GLO can help you.
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