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Should I Use a Seller-Financed Mortgage?

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Q: I’m buying a home and the seller has offered to personally give me a mortgage instead of me going through a bank. My credit is fine so it’s not like I need the help from the guy. I think he sees it as income to him on the interest payments. What are the positives and negatives of a deal like this?

A: There can be benefits to taking a mortgage from the seller, but this kind of deal isn’t without downsides, too.

Let’s start with the positives.

With a direct loan from the home’s seller, your closing could be faster than with a traditional lender, said Alan Meckler, a certified financial planner with Cornerstone Financial Group in Succasunna.

“Prudent buyers and lenders will always use the closing period to perform their due diligence,” he said. “But with seller financing, the closing process can be faster.”

Meckler said the closing costs may also be lower because they won’t have to pay bank fees and appraisal costs.

You may also have more flexibility on your down payment, Meckler said.

“Instead of having to meet a bank or government-mandated minimum, the down payment amount can be whatever the seller and buyer agree to,” Meckler said. “This does not necessarily mean that the seller will accept a down payment that is lower than what the buyer would be required to pay elsewhere, but it’s always a possibility.”

Then there are the potential problems.

For starters, you’ll still have to prove you’re a worthy borrower.

“It’s one thing if a buyer and seller just want to remove the bank from the equation,” Meckler said. “However, if a buyer doesn’t qualify for a traditional mortgage, there might be a good reason for that – and a seller may not want to become that person’s lender, either.”

You’ll still need to make sure the seller owns the house free and clear and that the seller’s lender, if there is one, agrees to the seller financing transaction.

You’ll also need to compare the interest rate offered by the seller to those offered by banks. Your seller may offer one that’s higher, or lower.

“It’s important to be sure that the interest rate is considered ‘reasonable,’” said Alison Williams, a certified financial planner with Stonegate Wealth Management in Oakland. “If not, a portion of the house may be considered a gift and would reduce your cost basis as the buyer.”

Williams said when dealing with a private mortgage, you’ll need to hire a lawyer. Banks are thorough and sure to record/file everything securely. With an individual, there is a good chance all they’ve thought about is receiving interest payments.

“There will likely be additional work a bank would usually take care of,” she said. “All the normal tasks that come along with a home purchase — inspections, obtaining title insurance, etc. — will still need to be addressed, however they will be on your plate; not the bank’s.”

She recommends you do a side-by-side comparison. Obtain a quote and list of services to be performed from a bank, then compare the terms and amount of legwork to the private mortgage offering.

And finally, be aware that the seller could eventually sell the promissory note.

“It’s not really a big deal if this happens, but it means that the person the buyer thinks he will be making his payments to can change,” Meckler said. “The same thing happens all the time with traditional mortgages.”

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