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Q: Marsha, I’ve been renting my home for 10 years. The owner has decided to sell. I love it here. He said he’d sell the home to me for a reasonable price. If I put money into the transaction, a down payment, he offered seller financing to help me purchase his rental. What is seller financing exactly?

A: Seller financing is another method in which to mortgage and purchase a home. If the sellers own the house free and clear, they may take the role of traditional lender. They’ll run credit, ask for a reasonable down payment, and have the transaction recorded. As with all mortgages in California, it will involve a promissory note and a recorded deed of trust. Sellers can also finance a second mortgage. In that situation, the buyer obtains a traditional loan from a bank and with the bank’s knowledge creates a second mortgage with the seller.

I had clients who used seller financing with great success. They purchased their home, and the owner financed the first mortgage. It was a sound business move for everyone. The house they purchased was a fixer — “teardown” is what the home inspector labeled it. Banks and traditional lenders would have been reticent to lend any money on it. By financing the house himself, the seller was able to sell the less-than-perfect home at a good price. The other advantage to the seller was deferring his capital gains. 

The house had been a rental for years. The seller was looking at a significant capital gains tax. By financing the home with a 30-year, fully amortized loan, the taxable capital gains trickled in. The bulk of any first mortgage loan is the interest payment with little principal being reduced in the beginning years. Owner financing helped the seller get his asking price and earn significant income from the first mortgage interest. 

My clients were first-time home buyers and were able to purchase more house than traditional lenders would have approved. Their closing costs were also lower. After interest rates dropped, they approached the sellers and asked for the market interest rate. The seller offered to match any bank’s rate. They ended up having a private first mortgage for seven years. 

Another common form of seller financing is when the owner carries a second mortgage. In this instance, the seller may still have his own mortgage but has enough equity in the house to lend the buyer. Say you want to purchase a house for $900,000 with 10 percent down. The bank doesn’t want to lend more than $750,000 on the house. With the first mortgage-holder’s permission, the seller makes a second mortgage for $60,000 to the buyers. The buyers can now purchase the home.

The advantage to the seller is that in addition to selling the house, she earns additional money on the interest payment. The terms are generally three to five years’ interest only with the principal balance due at the end of the period.

I say purchase your rental house from the owner and take advantage of seller financing. Sounds like a win-win for everyone.

Marsha Gray has worked in Santa Barbara real estate for more than 25 years. She works at Allyn & Associates, where she helps her clients buy and sell homes and with lending services. To read more of Marsha’s Q&A articles, visit Contact Marsha at (805) 252-7093 or DRE# 012102130; NMLS #1982164.


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