Seller financing: To get deals done, some owners give loans to buyers. Here's how it works
- Owner financed-deals make sense for buyers who have trouble qualifying for conventional loans
- It's good for sellers who are desperate to sell and don’t need to be paid in full immediately
The seller of a two-bedroom, two-and-a-half-bath condo, 534 West 42nd St., #PH8, in Hell's Kitchen, is offering financing.
Bond NEW YORK
The concept of a seller loaning a buyer the money to buy their property may strike you as impossible or strange but New York City brokers say it is neither. Instead, seller financing, a rare, yet creative way to fund a deal, is something you may start to hear about more frequently now that mortgage rates are inching past 8 percent.
It might take a minute to wrap your brain around it, but seller financing makes sense for buyers who have trouble qualifying for or are unwilling to get conventional loans, and sellers who are desperate to unload their properties and don’t need to be paid in full immediately. In some cases, it’s ideal for an otherwise financially qualified buyer experiencing a temporary setback, like a job loss.
Brokers, as well as buyers and sellers who have done it, tell Brick it’s a win-win for both sides of the closing table, but there are some precautions to take and pitfalls to watch out for. Read on if you want to figure out how to make seller financing work for your deal.
[Editor's note: This article was originally published in October 2023. We are presenting it again as part of our winter Best of Brick week.]
How does seller financing work?
When a seller offers financing, they are essentially acting as the bank. As with a typical deal involving financing, a buyer gives down payment for a percentage of the purchase price.
As for the remainder, instead of advancing a sum of money to buy their property, the seller agrees to accept an installment plan, usually for a rate that beats available mortgage rates. It could be a significant discount, like 3 percent, or one just a point or half point below what’s currently available, like 7 or 7.5 percent. Either way, with the principal and interest payments, the seller ends up making more than the purchase price over time.
All seller financing deals are different because flexibility is the name of the game here, but the terms could work like this: A seller would require a down payment of 25 or 30 percent and the buyer makes monthly payments for an agreed-upon loan term, which could be shorter than a typical conventional loan, a few years or as many as 7 or 10 years, with a final balloon payment at the end.
When owners must sell no matter what
A seller client of Michael Shapot, a broker at Keller Williams New York City, used seller financing to sell a unit in a landlease co-op building on East 63rd Street this year (a building with a landlease does not own the land it sits on). The land owners had ratcheted up the rent on the building and maintenance had mushroomed to nearly $6,000 a month.
The owner, a 97-year-old man who had already moved to an assisted living facility, needed to unload the property and seller financing provided a creative solution.
The 1,600-square-foot unit was originally bought in 1983 for $330,000. Initially, it was a three bedroom but a prior owner combined two of the bedrooms into an enormous den. The place needed a complete overhaul and as luck would have it, the buyer was an architect.
The seller agreed to a $450,000 purchase price but the board wanted a minimum sales price of $600,000, so the parties settled on a purchase price of $600,000 with an immediate closing credit of $150,000 to the buyer. The seller offered a 3 percent interest rate for a seven-year term with a balloon payment at the end.
Shapot says using seller financing helped make the co-op stand out.
“The seller recognized early on that offering seller financing was an effective way to distinguish their apartment from almost all of the others competing with it,” he says.
Sellers and buyers remain connected
With a typical transaction, sellers get their money and walk away, paid in full. Instead, if you’re on either side of a deal involving seller financing, you remain connected.
That’s perfectly ok with Vickey Barron, a broker at Compass, who has personally been involved with owner financing on four different occasions. These days, seller financing is something on which she advises her seller and buyer clients—and is something she's considering doing again.
Her first experience with seller financing was when she was in her 20s and she went to an open house and fell in love with a house in Orange County, California, that was out of her budget, an anecdote she describes in her new book, “Every Move Matters.”
Mortgage rates at the time were around 13 percent. The owner, a recent widower, was motivated to sell. He agreed to be the bank and carried the note at 3 percent. “A lot of people don’t think to ask,” she says, adding that it pays to think creatively.
Her second owner-financing experience was with a house in Seal Beach, California. When interest rates dropped, Barron could have gone to the bank to refinance but instead she asked the sellers, an elderly couple, if they would adjust the rate and they agreed, saving her $50,000.
The sellers kept the arrangement because they appreciated the monthly income. “It’s good retirement income,” Barron adds, likening it to an annuity. She’s been on the seller side too and says she feels the same way about receiving monthly payments, in fact the longer the better. In 2022, she financed a deal with a 30-year term, instead of the typical short term. Like many mortgage holders, buyers will usually refinance or sell well before the end of the term.
She currently has a property of her own for sale in Cape May, New Jersey, and is once again open to owner financing. In addition, she has a listing at 425 West 50th St., 14D, and the owner is open to seller financing. And next week she'll be listing an apartment at 115 East 9th St.
“The owner is open to seller financing but would need a minimum of 6 percent or 6.5 percent because otherwise, he can put the money in a treasury bill that is offering attractive rates,” Barron says.
Hunting for seller-financed listings
Desperate sellers—with an estate property or a unit in a building that has some kind of issue, like a big assessment—make the best targets for buyers to ask for seller financing.
But buyers may also come across listings being marketed with seller financing, like this two-bedroom, two-and-a-half-bath condo, 534 West 42nd St., #PH8, represented by Mariana Bekerman, an agent at Bond NEW YORK. The 2,157-square-foot duplex penthouse is asking $2,900,000. The seller recently decided to offer financing to spur interest.
Barron says the availability of seller financing is something “to put in bold letters.”
That’s because “banks today are much stricter and buyers have to go through so much scrutiny and bureaucracy. Marketing these properties with owner financing is very attractive,” she says.
What if a buyer defaults with seller financing?
As with any loan, there’s always the possibility of a default. With seller financing, the seller would repossess the property. That’s a plus for Barron.
“Think of this way, you are getting the interest and still own brick and mortar,” Barron says. “If they default, I got the down payment and I get the asset back.”
But for sellers of hard-to-sell properties—it’s not necessarily a good thing. Even though they pocket the down payment and likely some interest payments, a default sends them back to square one, and now they have a stale property to sell.
Safeguards for seller financing
You’ll need some professional guidance if you want to create safeguards for a deal using seller financing. A lawyer to draw up a contract between buyer and seller outlining the terms is a must, and Barron recommends consulting a financial planner as well so you can be sure the terms make sense for you.
Jonathan Helfer is a partner at law firm Romer Debbas and co-manages the firm’s residential real estate department. There are two significant points to be aware of, he tells Brick.
The first: If the seller offers a rate that is below the Applicable Federal Rate, the minimum interest rate that the Internal Revenue Service allows for a private loan, then it is considered a taxable gift. This is something frequently overlooked, he tells Brick.
The second piece of advice is to make sure the deal is recorded, Helfer says. That means the buyer pays mortgage recording tax (for condos and townhouses only). It’s pretty expensive.
If borrowing $500,000 or less, buyers pay 1.8 percent of the loan as a tax and if borrowing more than $500,000, buyers pay 1.925 percent.
That might seem strange, since seller financing is a means to avoid a mortgage. Helfer says if the buyer stops making payments, having the deal recorded provides additional documentation to aid in repossessing the property.
Seller financing is “actually quite nuanced with potential consequences for all parties involved,” he adds.
Another consideration is whether the seller owns the property “free and clear,” says Edward Kalisvaart, a broker at Keller Williams New York City, who has a seller that is considering offering financing.
If the seller doesn’t owe anything on the property, Kalisvaart explains, then the seller takes what’s called the first lien position.
“If the seller has existing debt, the seller financing will be in the second lien position, meaning they need to pay off the first loan to foreclose on the buyer” if the buyer stops making payments, he says.
“This process can take a long time in NYC, easily a year and involve a bunch of legal fees. That's why the down payment needs to be substantial enough to make up for both the legal fees, the headache, and the fact the seller will not be receiving payments during that period,” Kalisvaart says.
Buyers who need seller financing
Generally speaking, there are more buyers seeking seller financing than sellers offering it, says Ian Slater, a broker at Compass.
He’s working with a client selling a townhouse on the Upper East Side for $10,750,000. A buyer made an offer for 40 percent down at 5 percent that is contingent on seller financing because the buyer needs cash to renovate the place. Slater isn’t sure the deal will go through. “Honestly, it’s really tough to make this happen,” he says.
Still, he thinks there will be more transactions involving seller financing in the months to come.
Here’s why he thinks that way: A record number of deals that closed in the past year were all cash or buyers used financing and made their peace with higher rates.
“Now rates are even higher,” Slater says. “Buyers are less willing to accept higher mortgage rates,” he says, noting that transactions have decreased since Labor Day.
Kalisvaart is working with a seller of a $3 million property. They found a buyer, but at this moment, the buyer’s financial circumstances prevent them from getting the mortgage they would need for 70 percent of the purchase price. However, the buyer’s situation is a temporary setback.
“In about six months, they should be good,” he says. So the seller is considering a deal in which the buyer pays the full asking price and the seller finances it for a year.
Reasons why seller financing doesn’t make sense
There are other, more straightforward ways for buyers to get lower mortgage rates, points out Kobi Lahav, senior managing director at Living New York.
For example, buyers can reduce their rates with relationship discounts or paying down points. For sellers, he says, certificates of deposit are a better deal.
“Since some certificates of deposit and savings accounts are giving 5 to 5.5 percent liquid interest, it doesn't make sense for sellers of residential properties to give any kind of financing,” he says, adding that seller financing is a more common occurrence in commercial deals.
William Krooss-Tadas, an agent at Keller Williams New York City, also says that seller financing is not a trend. “Most sellers aren’t investors who can tie up their capital for a long term at a small yield,” he says. Plus, most sellers aren’t selling at all right now, he says, pointing to recent sales data. Manhattan co-op and condo transactions in the third quarter were down 23 percent year over year.
“Sellers can get more out of their capital in the bond market right now than they could self-financing. The only sellers that are selling right now are offering low prices because they need their liquidity. There aren’t many sellers who need to sell but don’t need their liquidity and are also willing to accept a lower price for less return than they could achieve by turning over their cash in six-month CDs,” Krooss-Tadas says.
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