Mortgages: When the Seller Is the Lender

But such transactions remain rare, according to market participants, largely because of eroding home equity.

In seller financing, the owner of a property holds the mortgage for the buyer, usually for about five years, with a balloon payment after that. For individuals who don’t need all the cash from a sale up front, the arrangement provides interest income, can delay or reduce capital-gains taxes, and gets a property off their hands.

For the buyer without a bank loan, it makes a purchase possible. Such deals were popular in the 1980s when mortgage rates topped 17 percent. (In New York, there have been recent instances of developers’ offering financing, especially in newer condominiums, but that’s a different market dynamic.)

Because a seller who acts as a bank has to be able to clear his own mortgage without the buyer’s cash, he needs equity — that is, he needs to own most or all of the property. Falling home prices in recent years have cut equity dramatically, said Mike Litzner, the owner/broker of Century 21 American Homes, which has 12 offices on Long Island. In this market, “the average seller lost 25 percent of equity from the peak of the market to today,” he said. “That loss of equity makes it harder for the average person to even consider financing.”

Century 21 recently released a survey of its franchisees and salespeople nationally; it found that 89 percent reported some customers’ having difficulty obtaining loans in the last six months.

Seller-financed deals do sometimes pop up, said Neil B. Garfinkel, a Manhattan real estate lawyer. His firm is handling a co-op purchase for a buyer whose mortgage from an institutional lender fell through. There was a quirk in the building’s finances that meant it didn’t meet underwriting standards. The seller stepped in, and it appears the deal will close.

That situation, he said, underlines a question that both buyers and sellers should ask as they consider owner financing: Why won’t the bank put up the money?

For the buyer, that may mean weighing whether the discovery of an environmental problem cools ardor for a house, or whether a low appraisal signals that an offer merits renegotiation.

For a seller who is in a position to provide financing, the biggest concern is whether the buyer is truly creditworthy. “Presumably the seller does not want to end up with the property back,” Mr. Garfinkel said.

Keep in mind that although such a transaction might seem less formal than bank financing, it shouldn’t be treated that way, said Ilona Bray, a lawyer and the co-author of “Selling Your House in a Tough Market,” published by Nolo.com.

“Get ready to really delve in and investigate” the buyer’s finances, she advises would-be sellers. Self-employed people are having a tough time getting mortgages now, even though they might otherwise be good risks. The seller should ask for several years of financial records, plus explanations for any less-than-perfect credit report.

Make sure deeds and other legal papers are filed according to local laws, Ms. Bray said, and ensure that documents lay out exactly how and when payments are due and what the penalties will be for late payments. “This is the kind of relationship where people could feel it’s casual,” she said. It’s not, and everyone involved must understand that defaults can lead to foreclosure.

From the buyer’s perspective, she said, if you’re considering such a deal, it’s probably because you realize you might have trouble securing a conventional loan. If that’s so, get your financial documents in order, and be prepared to ask sellers if they have flexibility. “Everything’s open to negotiation in the real estate world,” she added.

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