The real estate market looks very different from even 6 months ago, as market forces have been changing. What is different?
Demand Remains High
The number of buyers and sellers has not changed significantly. We still have a large number of buyers, either first time home buyers, relocations for jobs or lifestyle, retirement downsizing, and everything in between. The number of properties available still is much smaller than the number of people looking to get into a home.
Interest Rates Have Risen
Interest rates have risen significantly over the last 6 months. Where a year or two ago, we had interest rates in the 2-3% range, now interest rates have climbed all the way to the high 7% range, and that has put a large barrier in place for many home buyers, since their borrowing power has significantly reduced as the interest rates have climbed. Even a recent small drop in interest rates is not a big help, since we still are above 7%. But it does help a little bit.
Low Interest Assumable Loans Take Center Stage
Many buyers over the last 5-7 years have mortgages that have much lower interest rates than you can find today. Also, many of these loans have terms that state that a new buyer could assume the existing loan. We haven’t had a market with favorable conditions for assumable loans since the 1980s. Now 40 years later, the economy is shifting, interest rates are rising, and these existing low interest loans that are assumable have a lot of value.
What Does Seller Financing Look Like?
Let’s say a seller has a home value of $500,000. They have an outstanding mortgage of $250,000 with an interest rate of 3%. A buyer that wants to get a new mortgage would be looking at a 7% interest rate. What if the seller gave the buyer a loan for $450,000 at 5%, and $50,000 cash from the buyer? Then the seller is collecting 5% interest from the buyer, and paying 3% to the bank on their mortgage. Seems like it could work for everyone, right? The buyer gets the house they want at a lower rate than they could normally get, the seller gets a favorable financial deal, still able to pay their own mortgage, and keep a little extra on the 2% difference between the two. In this case the seller might not have the down payment to buy their next house. If they took a $250,000 down payment, that might be different.
What are the Risks of Seller Financing?
In the example above, what happens when the buyer can’t make a house payment. What does the seller do? If the owner of a loan is a bank, they would go through a foreclosure process, which would include several months of missed payment notifications, followed by notices to vacate, an eventually a bank sale, often at auction to recoup the money from the loan that the borrower defaulted on. Is the seller ready to follow a similar process if their buyer can’t make the payments? Can the seller continue to pay their existing mortgage, while missing month after month of payments from the buyer? Can they even legally foreclose?
More likely from a legal standpoint, the seller would be suing for performance on the loan, or filing to evict the buyer. And what about the title? Does it stay in the name of the seller, or does it transfer to the buyer, even though the seller still has a mortgage on the property?
How about instead of a sale, they do a Contract for Deed? A Contract for Deed is an agreement where the buyer would make payments to the seller for a specified period of time, but they would not get the title until the property is completely paid off. They would like get permission to move in, but the deed stays with the seller. This can create a risk to the buyer, that if they miss any payments, they could lose the whole contract, no matter how close to the end of the terms they are.
Another consideration is the bank that issued the original mortgage. When they issued the mortgage, they held the property as collateral for the loan. If the owner transfers title to another buyer, can the property still be collateral for the original mortgage? Most banks put a clause in their mortgage contracts that says that if the property transfers, then the entire balance becomes due and payable. That means that in our first example above, if the seller transfers the deed to the buyer, the bank can call the $250,000 mortgage due in full immediately. If the seller only collected $50,000 as a down payment, it is likely that they wouldn’t have the other $200,000 in cash ready to pay off the mortgage immediately. That means the bank could reclaim the property, and sell it to someone else to get their money back. Now the buyer doesn’t have the home either!
How would the bank find out? There are lots of ways. If the deed is recorded on municipal records, then they can search it anytime. They often run regular searches on title transfers for properties they hold a mortgage for. They can also see if the homeowner’s insurance changes, because they usually require that you pay the insurance payment into escrow at the bank, so that they can guarantee that the property is insured in case of damage. It can be difficult to hide the property transfer from the banks. For this reason, real estate agents are required in most areas to disclose to the seller the possibility of a due-on-sale clause in their mortgages, which could allow the bank to require full payment immediately.
What Should a Real Estate Agent Know?
If you are a real estate agent or real estate broker in a transaction like this, and you fail to warn your clients of this situation, will you be protected by Errors and Omissions insurance? Nope, this insurance only covers things that are not clearly spelled out in the law. If the law requires that you disclose, then the insurance doesn’t call that an error, they would treat that as fraudulent behavior, because any agent who completes a sales agent pre-license course to get their license would already know about this requirement to disclose.
Anything to do with a complicated legal transaction that has many elements coming together should only be done under the guidance of an attorney. The buyer and seller should both be informed about the risks they might face, get answers to their financial questions, and understand the market so they can make an informed decision. Let’s take good care of our clients.
Where Can I Learn More About Seller Financing?
We have a 2 hour course that talks about seller financing, the legal issues, and what any agent or broker would want to know about it, in order to help their client make the best decision possible. Check it out at this link.