The use of owner financing to sell either a home or business has become more prevalent for reasons such as the following:
- Difficulty by buyers in obtaining bank financing for home loans and commercial mortgages
- The real estate market continues to limp along in many areas
- Some sellers want to earn income on the loan, and the interest rate exceeds many other investment options
- Seller financing is one solution for a buyer with poor credit
- When combined with a bank loan, partial seller financing makes it a less risky loan for the bank
- For business loans, it shows that the seller believes in the business through their willingness to carry some, most, or all of the financing
Many homeowners and business owners would prefer to sell their property without providing personal financing. In most cases the rationale for doing so is to recoup all of their investment capital upfront via the mortgage loan process involving a traditional lender.
But whether they really want to or not, more real estate sellers are being drawn into the loan business for reasons such as those listed above as well as many other individual circumstances. For example, owner financing for a few years is quite common among family members when a relative decides to sell the family home or family business to a relative such as one of their children.
Replacing One Financial Risk With Several Financial and Legal Risks
Essentially property owners are attempting to avoid the risk of not selling their valuable investment in a timely manner by offering several possible variations of seller financing. But in almost all cases, they are actually exchanging one risk for several others. Some of the legal and financial risks which are present with most versions of owner financing can be controlled and managed, but sellers need to be prepared for the fact that they are embarking on a potentially risky journey.
Risk management primarily involves anticipating some things that could go wrong after ownership is transferred to someone else. It is especially important to talk to several trusted advisors before finalizing anything. A legal expert is particularly an important individual to involve early and often in this process.
One of the biggest risks is also not generally controllable in practical terms, and this is when a seller provides a second mortgage with the first mortgage provided by a traditional lender such as a bank. The seller is potentially exposed for the entire amount of the second mortgage if the primary loan goes into a default and foreclosure.
The extreme risk of providing secondary financing is actually a primary reason why some owners choose to bypass the opportunity of bank financing and effectively become a personal banker. There can still be other risks lurking around the corner. Some of these are the following examples:
- The new owner is short of funds and does not keep their insurance coverage in effect. Property damage (whether intentional or not) occurs which is now not properly insured.
- Property taxes are not paid on time and a tax lien is issued.
- The new owner has an income tax debt with the Internal Revenue Service, and the IRS places on a lien on all of their current assets.
The list above was designed to provide several common illustrations of seller financing risks, but unfortunately the list does not even begin to end there. With some expert help obtained in advance (before the problem occurs), most of these potential risk areas can be managed effectively.