by Zain Jaffer
After a year of Fed rate hikes on the overnight lending rate, plus a credit rating downgrade of the US Government by Fitch Ratings, we can expect that the high interest rate regime will be with us for a while. When the Fed rate was just in the one percent range prior to the hikes, the mortgage rate hovered at around 3% per annum. With all the Fed rate hikes, the average mortgage rate now hovers at around 7-8%.
Not too many homebuyers want to sign up for that. Banks are now extremely picky about who to lend to, because of the high cost of capital. Already foreclosures of real estate are expected to go up, as many individual and corporate buyers can’t cope with the readjusted higher monthly payments, especially if they are not generating enough revenue on commercial property, or for home buyers, their salary or business income is not enough to sustain higher payments.
With this in mind, and with some sellers really wanting to sell their house with few buyers, some are turning to seller financing. In seller financing, the seller basically acts as the bank and allows the homebuyer to pay in installments over time (a mortgage). The agreement takes the form of a contract where the payments need to be completed before ownership is transferred, with penalty clauses. In many instances, it is the developer or an entity that has many properties in their portfolio that they cannot sell.
This happens between people who know each other like friends and family as a private arrangement. But it also happens with private developers or those with multiple property holdings who want to sell in a tight market.
Since banks handle a lot of these mortgages, those bank mortgages are often bundled and securitized as Mortgage Backed Securities (MBS) and sold on the open market. Even the Fed and other entities buy MBS from issuing banks. Unfortunately seller financed private mortgage agreements cannot be bundled into these public MBS.
Obviously there are many risks. Large banks and corporate entities often have experienced legal staff ready to go to court on a regular basis for foreclosed property sales and it becomes par for the course for them. For individual sellers however, it becomes problematic as it could involve a court case if the buyer defaults or violates the terms of the contract.
From the buyers perspective, it is easier to get approved for a seller financing agreement. Sometimes buyers get an advantage with a lower interest rate than market as all the seller cares about is the purchase price. Seller financing should be cheaper in most cases also as there is less due diligence and no fees / commission that the bank charges. If the seller wants to stick firm to the asking price, but the buyer wants a lower price, one way they do it is to extend the payment period but at a lower interest rate compared to the banks.
There are many possibilities. Higher payments now then lower payments in the future, or lower payments now then higher payments in the future if interest rates adjust. It depends on what the seller and buyer mutually agree to.
There’s also downpayment assistance. Companies like Zillow are now willing to add as much as two percent for your downpayment if a buyer signs up. So even if a buyer only has one percent for a downpayment, they can add two percent to move up to the minimum three percent downpayment just to get a buyer to sign up for a mortgage.
Since the contract also acts as an encumbrance on the property title, the seller cannot immediately sell the property to other buyers if the first buyer defaults. That agreement first needs to be canceled and the status of all the money already paid by the first buyer needs to be clearly decided on based on the contract or a subsequent case if one is filed.
Obviously you shouldn’t undertake seller financing without the assistance of an experienced real estate lawyer assisting you in all contracts and discussions. Both parties may find issues they never considered if they proceed without legal assistance.
As the property market and banks gets squeezed by the higher rates, expect to see more seller financed real estate sales in the foreseeable future.
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