What is Seller Financing and How Does it Work?

By Bob Walsmith Jr.
2022 President
Santa Barbara Association of Realtors

Competition in this current housing market is stiff. Low supply and high demand are just two factors complicating the home search for many prospective buyers. Not only that, but qualifying for a traditional loan can be difficult, especially with the current rise in interest rates. One option outside the norm is seller financing. With seller financing, the owner of the home offers the buyer a loan. Thus, you can avoid the pitfalls and challenges of the traditional mortgage experience. Seller financing offers several benefits, such as lower closing costs. But they come with their own challenges as well. Here’s how this lending process works and whether it’s right for you.

What Is Seller Financing?

Seller financing is an alternative way for a buyer to purchase their home. Essentially, the seller becomes the lender and extends credit to the buyer so that they can cover the purchase price of the home (excluding the down payment). So, you effectively cut out the middleman – i.e., a traditional lender. The seller oversees the debt instead.

How Does Seller Financing Work?

When you enter a seller financing agreement, the seller acts as the lender. So you, the buyer, purchase a home from the seller with no involvement from a bank, credit union or other traditional lenders. The seller only extends credit to the buyer, though, not cash. Once they do, the buyer makes regular installment payments to the seller. They do this until they completely pay off the balance owed.

Although this agreement doesn’t involve lending institutions, the buyer and seller often use other professional help. Many times, they rely on attorneys and Realtors® to facilitate the purchase. Professionals in these fields also take the lead in generating the terms of the agreement. However, the buyer and seller may negotiate factors such as the loan’s length or interest rate. Seller financing generally functions in two ways.

One, the buyer receives the house title after pledging to pay the seller’s offered loan. The buyer can then refinance or sell the property but continue to make payments to the seller per their agreement.

Or, two, the seller keeps the house title until the buyer fully repays the loan. Only afterwards do they receive the title.

In either case, the seller often requires the buyer to complete an application, go through a credit check and offer a down payment. The seller may also demand certain requirements, such as an appraisal of the home. Or they may insist on retaining the right to foreclose the property if the buyer defaults.

If both parties agree, they must sign a promissory note that contains that loan’s terms. Then they file a mortgage (or deed of trust in some states) with the local public records authorities.

Is Seller Financing Right for Me?

Today’s housing market is highly competitive. So, you may find the home of your dreams, but it’s out of your price range. Or, perhaps, you struggle with qualifying for a traditional loan. Either way, seller financing can open the opportunity of homeownership to you. And you would have potentially advantageous terms, too, such as a low-interest rate, low minimum down payment and fewer closing costs.

But there are risks to seller financing. Contracts can include unfavorable terms, like a higher interest rate or a too-short repayment period.

If you struggle with meeting the criteria for a conventional loan, consider all your options. Seller financing isn’t the only router. There are other loan types that come with relatively lenient requirements.

The Bottom Line

While it can be hard to find a perfect loan, you shouldn’t rush into any lending agreement. Seller financing may be right for some buyers. But it heavily depends on the seller and the terms they offer. Before you explore this option, consider hiring an attorney. They can ensure that your rights as a buyer are upheld. Or they can help you walk away if negotiation is impossible. Remember to explore all your options before you choose, though. There are other loans out there that come with lower credit requirements which may make more sense for you.

Bob Walsmith Jr. is a native to Southern California and a Realtor® with Berkshire Hathaway HomeServices California Properties in Santa Barbara. During his work with the Santa Barbara Association of Realtors, Bob has served on the CORE Committee, Education Committee, been Chair of the Budget & Finance Committee, and the Multiple Listing Service Committee. He also is on the Board of Directors of the Alpha Resource Center of Santa Barbara. Bob lives in Goleta with his beautiful wife Julie. When not working, Bob enjoys playing golf, fine wine, fine dining, and walking our beautiful coastline. Bob can be reached at 805.720.5362 and/or bob@bobwalsmithjr.com