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Q: Last week, you said qualifying sellers could keep all their profits tax free, even if they received those profits in the form of an owner-financed mortgage. Why would any seller want to take such a risk when the buyer might default on his payments?
A: According to government statistics, about 40 percent of the homes in America are owned free and clear of any mortgage obligation.
When these homes sell, the owners typically have the opportunity to offer some form of financing in association with the sale, if they choose.
There are several compelling reasons for a seller to offer owner financing:
> It can make the house sell faster. There is a substantial segment of the population who simply cannot qualify for any type of traditional loan program, yet wants to take advantage of the benefits of home ownership.
Recently bankrupt individuals are an example. Let’s say a family has a catastrophic medical situation that results in the death of the primary wage earner. The remaining spouse is left with impossible medical bills, plus a family to support.
Even though the remaining spouse may have a good job, it still might be best to declare bankruptcy to allow the family to have a fresh start. This person might be an excellent candidate for owner financing.
Another example might be a person recently re-entering the job market and having no history of employment or no credit history. This person might have difficulty qualifying for a traditional loan but might be able to comfortably afford the required monthly payments.
By marketing the home as affordable and available to those unwelcome in traditional lending situations, the home could sell much quicker.
> Owner financing offers investment alternative. Most sellers who own their homes free and clear of any debt are seniors and often have a need for income to supplement their retirement dollars.
Because it is considered totally safe, many sellers turn to certificates of deposit to invest the equity they receive from the sale of their residence.
But yields of CDs have dropped dramatically over the past year, and many seniors are looking for alternatives.
Enter the seller-carried mortgage, where the seller can require a substantial cash down payment, dictate his own term of investment, remain fully secured in the investment and receive a relatively high yield at the same time.
> Down payment. The amount of cash paid to the seller at closing is open to negotiation between the parties. Typically between 5 and 20 percent of the purchase price, this down payment is not refundable, and serves as an incentive to make sure the buyer meets his obligations. The more the seller gets, the more secure the loan becomes. Conversely, the lower the cash required, the more attractive the financing becomes.
> Terms of payment. Most often, sellers offer financing based on a 30-year fixed-rate loan. That’s because such a loan is the standard in today’s housing market, and most buyers understand how it works.
But most sellers don’t want to tie up their cash for the next three decades. So the solution can be a “five-year call.”
A 30-year loan with a five-year call simply allows the lender to call the loan due in five years’ time, if he desires. That way, if interest rates have risen substantially or the seller prefers to do something else with his money, he can force the buyer to refinance or even to sell the property to pay off the loan.
> Loan security. Smart sellers who offer owner financing use a real estate attorney to handle the transaction. The attorney will make sure that the seller receives not only a “note” at closing but also a “deed to secure debt” that posts the property as collateral for the loan.
Georgia law provides for “non-judicial” foreclosure, meaning that if the borrower fails to make payments as agreed, it is relatively easy to force the property to be sold at auction to satisfy the debt.
The lender does not have to sue the borrower, and the borrower has no right of appeal. As a result, the loan is considered quite secure.
> Relatively high yield. There is always a trade-off between risk and return, and owner financing is no exception.
While a bank CD is backed by the full faith of the U.S. government, the return is modest.
While an owner-carried mortgage can have a nice yield of 7 to 10 percent, the possibility of default is higher. Even so, with a solid down payment and a strong security deed, the chances of loss can be minimized.
Owner financing is certainly not for everyone. But it can be a very attractive alternative for an owner who understands the risks and appreciates the potential rewards.
Written by: John Admas, For the Journal-Constitution

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