By Asheesh Advani

Seller financing of residential real estate transactions has been around for as long as properties have been bought and sold. In recent years, however, we have seen a renaissance, as this age-old approach is increasingly used in the disposition of residential properties purchased for investment purposes.

In seller financing - also known as "owner financing" or "seller carry-back" - the owner of a piece of property takes a promissory note back on all or part of the sale price of a property. In effect, the seller acts as the bank for the buyer. The promissory note is then secured by a mortgage, allowing the seller to maintain a lien on the property.

Seller financing is very often used by foreclosure investors - when they're buying and when they're selling. Once the foreclosure auction occurs, of course, seller financing is no longer an option. Up until that point, however, the home owner is still the legal owner of the property, and can sell to anyone (in any manner) - as long as his or her debts are satisfied. In practice, this means that the existing mortgage would need to be paid off, but some of the equity - either with small monthly payments, a balloon payment once the property is sold, or an escalating payment schedule - might very well be seller financed.

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What's in it for the buyer?

If you are the buyer, the benefits of seller financing are many. With the steady rise in interest rates and property values in recent years, many buyers have had to settle for less house than they wanted, or pass on attractive investment properties. Seller financing, with its lower closing costs and reduced initial investment, may allow you to purchase a property that would have been out of reach with traditional financing.

In addition, if you have a poor or insufficient credit history, without seller financing you could be kept out of the home or investment property market entirely. Making regular payments via a seller financed mortgage, on the other hand, allows you to get into the game, begin building equity, and repair/build your credit history in the process.

What's in it for the seller?

For the seller, there are a number of advantages to financing the sale:

• It broadens the pool of potential buyers. There may be an otherwise attractive buyer who is shut out of traditional financing markets due to factors such as citizenship status, insufficient credit histories or lower credit ratings. Also, the buyer may simply not have the substantial down payment typically required.
  
  In addition, a particular property may be unattractive to traditional lenders and therefore difficult to finance. For example, it may need lots of repair or be considered "too rural." By offering a financing alternative in these situations, the seller increases the supply of potential buyers. As a result, the property may sell faster and at a higher price.

• It offers an alternative to leasing. Many sellers are seeking a steady stream of income - either to avoid the tax impact of a lump sum payment or for other reasons. In these cases, acting as the seller-financer can be an excellent option. Interestingly, many investors we talk with report a better monthly payment experience with owners than with renters regardless of credit scores, even when down payments made by buyers are insignificant. They also report that properties are better cared for by owners than by renters.

Making it work

The greatest risk to the seller-financer of course, is that the buyer may not make payments. And while the seller would still have a lien on the property - and therefore the right to foreclose for nonpayment - it's in nobody's interest for this worst case scenario to play out.

With that in mind, some suggestions for buyers to help keep things on track.

• Help the seller to check you out. An experienced seller knows that many individuals classified as "high risk" by traditional sources may in fact be perfectly good lending risks. Others potential buyers, however, deserve this designation as a result of their past history. Do whatever you can to demonstrate to the seller-financer that you are a risk worth taking. Be up front with information - both good and bad - and help the seller to become comfortable with working with you.

• Pay on time and communicate immediately and honestly if you run into a problem. It is never in your best interest to avoid or mislead the seller if you can't make a payment. As with any relationship, honest, up-front communication is the key to making it work.

With rising interest rates, rising prices and a more varied pool of buyers, seller financing is a valuable strategy for all concerned.

Asheesh Advani, PhD, is founder and president of CircleLending, Inc., an administrator of private loans with a special focus on residential mortgages. CircleLending is based in Waltham, Massachusetts. For more information, visit www.circlelending.com or call 1-800-805-2472

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