I was reading Wall Street Journal’s Online Personal Finance Section and came across a very interesting article, that in my humble opinion, didn’t explore the downfalls of Seller Financing enough. The article was entitled “Mortgage Lending for Sellers” by Amy Hoak (full article can be found here).
What is Seller Financing?
The idea of seller financing is easy, instead of your local/international bank loaning you the money, it is Mr. or Mrs. Seller which provides the terms for your mortgage. As you can imagine, seller financing is going to get more and more press as traditional means of credit become tighter and tighter. Additionally, as Ms. Hoak points out,
Seller financing can help buyers who may be having trouble getting a loan because they are self-employed or work on commission.
Reasons not to do Seller Financing
This leads me to my first point, one not even brought up by Ms. Hoak – why do you, Mr. Seller, think you are better at evaluating someone’s risk? Lets ignore, the situation of family members lending to each other (which is questionable at best to begin with), you, as a seller, are going to make the decision to lend someone money when a bank, whose sole job is to lend money has decided against it? I know most banks have made mistakes lately, but that doesn’t mean you have to also.
The second problem is one of liquidity, what is the old saying? Every buyer is a seller? To be fair, Ms. Hoak states that this shouldn’t be used for those that need the money to buy their next home.
Alright, even if we were to ignore your credit evaluating skills, and liquidity issues, there are issues of default that is not explored by Ms. Hoak. Specifically, she only says that,
But if the buyer defaults on the loan while the seller is holding the paper, the seller may need to reclaim the property through foreclosure.
And that’s it??? No details about foreclosure and what that entails. As wikipedia defines it,
Foreclosure is the legal proceeding in which a mortgagee, or other lienholder, usually a lender, obtains a court ordered termination of a mortgagor’sequitable right of redemption.
As soon as you see the words “legal proceeding” you should think timely! When you enter into this kind of agreement, you are precluding the fantasy situation of you as seller come in and change all the locks. From my brief experience in this area, you are talking 6 to 9 months of foreclosure…is that what you were thinking about when you decided to become a seller and a bank? Probably not.
A bigger problem? When the foreclosure process is halted when your purchaser/mortgager (mortgagee is the bank its one of those weird legal terminology things) goes into bankruptcy! So now you can’t use the property you sold AND ARE NOT GETTING MONEY IN!
While I generally like the article I really think it needed more details into the downfalls…BE CAREFUL!