Seller Financing is when the seller is the lender. I works like this – the seller passes ownership of the property to the buyer by deed. The deed describes whatever matters affect the ownership (or title) to the property and contains a promise by the seller to defend the buyer’s ownership (or title) to the property. The seller gets a note for the difference between the sales price and cash paid by the buyer; this is money owed to the seller. The note generally provides for equal payments of principal (what is required to pay off the amount owed/borrowed over the time provided for repayment) and interest (the extra amount paid, as profit to the seller/lender, for having provided the money). Because of the interest, a note is a type of investment (a way the seller/lender can make money). The property becomes the security for the note: the seller/lender gets the property back if the buyer does not pay the note as agreed. The mechanism used to make the property security for the note is a document called the “deed of trust.” This document creates a lien against the property. When the note is paid in full, the seller/lender releases his lien, and the buyer owns the property “free and clear” of the lien. If the note is not paid as agreed, the seller/lender can recover ownership of the property by foreclosing on his lien.
Here are some negotiable points when using seller financing:
• Typically, the buyer pays taxes and insurance. The seller/lender can decide to collect the money to pay these items along with the monthly payment on the note (collecting 1/12th of what will be due and paying the tax or insurance premium when it becomes due) or to allow the buyer to pay these items directly and provide proof of payment. The appropriate provision must be put in the deed of trust.
• If the buyer is late in making the monthly payments due the seller/lender, a late charge (typically 5% of the payment amount if the payment is made more than ten days after it is due) can be collected by the seller/lender along with the payment. The appropriate provision must be put in the note.
• If the buyer wants to pay off the note early, before the scheduled payoff date, the seller/lender, who will not receive all of the interest he would have received over the full term of the note, can charge a prepayment penalty. However, the prepayment penalty cannot exceed the amount of interest the seller/lender would have earned if the note had been paid as scheduled.
• In the event that the buyer wants to sell the property before the note is paid in full, the seller/lender must decide whether he will allow the note to be assumed by a new buyer or require that the note be paid off at the time the buyer sells the property. The appropriate provision must be put in the deed of trust.
o If the seller/lender allows the note to be assumed, there is a requirement that the seller/lender be satisfied regarding the new buyer’s credit and ability to repay the note. The seller/lender must also decide whether the original buyer will remain liable to pay the note or will be released from liability to pay the note.
o If the seller/lender requires that the note be paid off, then a “due on sale clause” is put in the deed of trust.
• If the deed of trust contains a “due on sale clause” and the buyer sells the property without paying the note to the seller/lender, the seller/lender can get ownership of the property back by foreclosing on his lien.
• Prior to the foreclosure process, the buyer would be given certain notices. If the buyer fails to pay what is owed, the property is sold at a public auction to the highest bidder.
o If the property is the principal residence of the buyer, then the buyer must be given a warning notice that the payment under the note is delinquent. The buyer is given 20 days from the date of the sending of the notice to pay what is currently owed. (If the property is not the buyer’s principal residence, then this notice does not have to be given.)
o If the buyer does not pay the delinquent amount in full, then the seller/lender can “accelerate the note”; the seller/lender can say that all money due under the note (whatever is required to pay the note in full) is due. A notice that the note has been accelerated is sent to the buyer.
o A Notice of Foreclosure Sale is filed with the County Clerk and put up (posted) at the place in the county provided for public notice of foreclosure. The Notice of Foreclosure Sale is also sent to the buyer, usually with the notice that the note has been accelerated.
o Foreclosure sales are held on the first Tuesday of each month. The Notice of Foreclosure Sale must give the buyer at least 21 days to pay everything that is due on the note. Therefore, the foreclosure sale will be held on the first Tuesday of the month that occurs more than 21 days after the Notice of Foreclosure is sent.
o The foreclosure process is generally conducted by the Trustee under the deed of trust. If a foreclosure sale does occur, the Trustee takes bids from all interested parties. Usually the seller/lender bids the full amount owed on his note, and usually the seller/lender is the successful bidder. If someone else bids more, that person has to pay cash for the property, and the seller/lender’s note gets paid off.
o The Trustee conveys the property to the successful bidder at the foreclosure sale, and the buyer loses ownership to the property.
• There are two (2) situations which can interfere with the foreclosure process:
o The buyer can file bankruptcy. In this situation, the seller/lender will either be allowed to foreclose, but under the timing allowed in the bankruptcy proceeding, or the note will be paid off in accordance with a plan developed in the bankruptcy proceeding.
o The buyer can die. In this situation, the seller/lender can foreclose after a probate proceeding on the buyer has been started or after the seller/lender can identify the buyer’s heirs-at-law.
• Lender’s title insurance (loan policy). The seller/lender should get a loan policy that insures the lien created by his deed of trust.
o The loan policy protects the seller/lender against title defects, but is particularly useful if the seller/lender wants to sell the note and get cash, rather than waiting for the note to be paid off.
o If obtained at the same time as the owner policy to the buyer, the loan policy only costs an extra $100 plus endorsements. If obtained later, a credit may be given, but the charge will not be as minimal as it would have been if the loan policy was obtained at the same time as the owner policy to the buyer.
Want to know more about Contract for Deed?
Below is the process:
1. The seller and buyer execute a document called a Contract for Deed. By law, the document must be recorded in the real property records of the county.
2. The document provides that the seller/lender does not provide a deed to the buyer until the purchase price for the property is paid in full. The payment of the purchase price is similar to payments on a note, and the payment schedule is set out in the Contract for Deed.
3. If the buyer does not make the payments set out in the Contract for Deed, the seller/lender can take possession of the property.
a. If the buyer has paid less than 48 payments or less that 40% of the purchase price on the Contract for Deed, he is given a notice of delinquency. If he does not pay the delinquency within 30 days, the seller/lender can cancel the Contract for Deed, take possession of the property, and record a notice canceling the Contract for Deed in the real property records of the county.
b. If the buyer has paid more than 48 payments or more than 40% of the purchase price on the Contract for Deed, he is given a notice of delinquency. If he does not pay the delinquency within 60 days, the seller/lender can foreclose in the same way that a deed of trust would be foreclosed.
Some considerations:
• The risk to the buyer is that the seller/lender may do something to affect the title before the buyer can pay off the purchase price and get the deed from the seller/lender. Recording the Contract for Deed protects the buyer against any creditors of the seller/lender that have rights arising after the date that the Contract for Deed is recorded.
• The Contract for Deed is often used when the buyer does not qualify for a loan at the time of sale but expects to obtain a loan in the foreseeable future.
• Title insurance may be issued on a Contract for Deed transaction. Only an Owner Policy is issued (because there is no note and lien, just a contract for the buyer to pay money and the seller/lender to convey title sometime in the future). The insureds under the policy are both the seller and the buyer.
• A real estate commission can be collected on a Contract for Deed transaction.
