Some homes take longer to sell than others, adding anxiety to sellers who absolutely have to get a transaction closed within a specific period of time. And, when it rains, it pours.
For example, I recently got a call from a former college classmate who had taken a new job in a different state. After his home sat on the market for months, he finally struck a deal with a potential buyer. For weeks the deal appeared to be headed to closing, and the seller, feeling confident with the buyer’s borrowing power, had even made a down payment on another home. The seller became upset, however, when the buyer walked away from the deal because the buyer would not agree to a “soft prepay” loan provision offered by a national lender.
A “soft prepayment penalty” or “soft prepay” loan is a requirement some lenders now are demanding to help curtail borrowers from quickly refinancing their loans as soon as interest rates drop. The “soft” limitation allows the borrower to prepay the loan without penalty only if the home is sold. However, if the loan is refinanced during a specific period of time, typically three to five years, the borrower faces a prepayment penalty that could amount to thousands of dollars.
If you have a home that’s been sitting on the market and you truly need to sell and move on, you could include in your advertising materials that you would be willing to offer seller financing for a specific period of time provided you receive a sizeable down payment. The down payment would supply you the cash to get into your new home, and the monthly payments made by the buyer could offset the payments of your new home. You also get to better gauge your moving time, and the buyer avoids loan costs.
“Carrying back” all or a portion of the proceeds can make a lot of sense. Most of the time, seller financing works well for both sides, but both sides — especially the seller — should be prepared to handle the deal much like a small business. While the buyer can simply mail you a check every month, it’s up to you to craft the ground rules.
If you participate in any sort of seller financing, make sure to build in safety features that protect your investment and sanity. In fact, it’s not a bad idea to copy many of the loan requirements a local bank would insist upon — especially if you will be out of the country most of the year.
Here are some seller-financing tips to consider:
- Consider a third-party collection account. You can split the cost with the buyer, and the service is well worth the money. It provides you with complete tax statements (seller must submit principal and interest amounts to the buyer-payer annually). The account receives and deposits monthly payments — especially valuable if you have to go out of town unexpectedly.
- Write into the earnest money agreement that the buyer provides and keeps current a homeowner’s insurance policy.
- Purchase tax registration coverage from a title company. That way, if the property taxes are not paid, you will be notified. Include in the earnest money that the buyer make timely tax payments.
- Insist on a “due-on-sale” clause or that you, as the initial seller, must approve any subsequent sale in writing. That way, if the property is sold before the term of your note or contract, you will receive all your cash upon the transfer of the property, or retain the ability to approve the new buyer.
- It’s a good idea to obtain a credit report on the buyer. Why would you want to sell your home or other property to someone you know nothing about?
- If you absolutely cannot be cashed out early (say you need monthly income or do not want to pay taxes on the lump-sum gain) request your own prepayment penalty. That way, if you receive a huge balloon payment when you don’t necessarily want it, you will be reimbursed for the inconvenience (tax consequences, loss of reliable income, etc.)
- Consider taking a down payment of at least 20 percent. If you need to sell the note before term (illness or other emergency) this will make it easier to sell. Like regular mortgages, lenders require mortgage insurance for loans they write with less than 20 percent down. You will reduce the risk of any future note holder by having an amount at least equal to a conventional down payment.
Seller financing is not for everyone. But not everyone is faced with the deadline of 30 days to be in a new job in a different state.
Tom Kelly’s new book, “Cashing In on a Second Home in Mexico: How to Buy, Rent and Profit from Property South of the Border,” was written with Mitch Creekmore, senior vice president of Houston-based Stewart International. The book is available in retail stores, on Amazon.com and on tomkelly.com. Tom can be reached at news@tomkelly.com.
