What is a Seller-Financed Sale
A seller-financed sale involves a purchase in which the seller extends a loan to the buyer in lieu of payment. The buyer then pays off the loan with interest.
BREAKING DOWN Seller-Financed Sale
A seller-financed sales cut out third-party lenders along with their associated qualification processes and fees, making them an attractive option for transactions where the seller does not require payment up front. For purchases large enough to require a borrower to take out a loan, a seller-financed sale behaves the same as a bank-financed sale would. The buyer makes payments in installments and pays an agreed-upon interest rate. Sellers receive the purchase price of the asset plus interest, though the seller must also assume the risk that the buyer may default on the loan.
Bank financing can be difficult for homebuyers in unusual financial situations or those without a solid credit history. Likewise, some sellers do not necessarily need, or even want, the large lump sum of cash that comes with the sale of a large asset, such as a house. For example, a retired couple who own their home outright and seek a smaller residence might find a tax benefit to funding the buyer's mortgage themselves. In a tight mortgage market, the seller might also consider such an arrangement just to get the sale underway, especially if potential buyers have issues finding decent financing. Even if the sellers did need the cash for a down payment or for some other reason, they could self-finance the loan and then sell it to a third party at a later date, provided they could find a willing buyer.
Pros and Cons of Seller-Financed Sales
From the buyer's standpoint, seller financing can provide a smoother, cheaper closing process, since both parties can bypass the mortgage qualification process. The seller still must draw up a promissory note defining the terms of the loan and the contractual obligations of the buyer. Seller financing may allow buyers more flexibility in their down payment, as opposed to minimums required by bank or government loans. Such financing could also allow buyers to avoid mortgage insurance payments that a bank might require for down payments under a certain size. Interest rates also might provide a point of negotiation for seller-financed sales, but the Internal Revenue Service (IRS) maintains rules governing the minimum amount of interest a lender must charge on a loan. Sellers may also require higher rates than a bank would, since they assume the risk of the loan themselves.