Why Seller Financing may be an Alternative to Consider in Commercial Real Estate Transactions

The commercial real estate market has steadily improved since the 2008 financial crisis. Traditional financing is readily available, but seller financing may be another viable option for many investors.

A Sell-to-Finance mortgage loan is secured by the property, and a mezzanine sell-to-Finance loan is secured by the property of the business being purchased. The seller can use this type of arrangement to obtain cash to pay sales or debts or to satisfy investor requests for repayment. Alternatively, the seller may choose seller financing to raise capital for other business ventures or to create liquidity for the entire portfolio.

What is Seller Financing?

Seller financing is an alternative for buyers to purchase a home. By default, the seller becomes the borrower and provides a loan to the buyer to cover the purchase price of the home (excluding the down payment). That is, it effectively eliminates the intermediaries, i.e., traditional borrowers. Instead, the seller controls the debt.

Seller financing, sometimes called payday loans, is sometimes attractive to people trying to get traditional loans. For example, they may have low credit worthiness. However, sellers can be more flexible than banks, especially when it comes to down payments.

When is the best time to finance a seller?

Here are a few examples of how seller-financed agreements can work for both parties.

A mutual desire to save time and money. Buyers and sellers who know each other well, such as parents and children, may want to remove the extensive paperwork and expenses of conventional mortgages and handle them themselves. These situations require a high level of trust and attention, but both sellers and buyers enjoy a faster closing process, lower closing costs and no ongoing fees or charges from lenders.

Urgent repairs are needed. Sellers who don’t want to renovate a home that will help them pass a Federal Housing Agency or Veterans Administration pre-finance inspection can find a buyer to renovate it. If the homeowner doesn’t take care of the home before he or she dies, that can happen when the property is sold, and the children who inherit the home know it needs a lot of repairs before it goes on the market.

“Sellers who can’t do that now have a solution.” says Minchella. Buyers have a better chance of making repairs, getting a mortgage or selling and getting an increased value on their home.

What are the risks of Seller financing?

Sellers have to be careful when making these deals. First, sellers should make sure they are eligible to become borrowers. Examining organizational documents, joint venture agreements, funds or higher level debt agreements, and applicable regulatory requirements will help you determine if the seller can create and hold a loan. If necessary, the seller may modify and surrender certain documents.

The seller must comply with all applicable loan laws related to national licensing, bond and securities collection. They must also assess whether they have the necessary skills to get started and make loans. Finally, the seller must determine if the property is suitable for this type of arrangement. Financially sound properties will provide optimal results for buyers, sellers and third-party borrowers. However, a vacancy-rich property may not generate the income the buyer needs to meet his or her obligations to the seller and tenant, let alone make a profit.

Another consideration is to make sure that the current loan on the property entitles the seller to prepay without paying a penalty. The cash proceeds from the sale must be sufficient to pay off the existing loan.

In addition, transactions involving third-party borrowers are more likely to put the seller in the position of a dependent borrower. However, in these situations, the seller may demand a higher interest rate because of the increased risk.

Finally, when a buyer is found, the seller should conduct a thorough due diligence to ensure that the buyer is creditworthy. The seller should review the buyer’s financial statements, credit history, tax returns and similar records. Sellers should also ask for bank and business references.

How does seller financing work?

When you enter into a seller financing agreement, the seller acts as a lender. So, as a buyer, you buy a home from the seller without any interference from a bank, credit union or other traditional lender. The seller extends credit only to the buyer and does not provide cash. Once that happens, the buyer pays the seller a regular payment. They do this until they have paid off the balance due in full.

Although lenders are not involved in this agreement, buyers and sellers often enlist the help of other professionals. They often rely on lawyers and real estate agents to facilitate their purchases. Experts in these fields also take the lead in creating the terms and conditions. However, the buyer and seller can agree on factors such as the term of the loan or the interest rate.

Seller financing is usually done in two ways.

First, the buyer takes title to the home after entering into an agreement to pay the loan submitted by the seller. The buyer can then refinance or sell the property, but can continue to pay the seller according to their contract.

Or, second, the seller retains title to the home until the buyer pays off the loan in full. Only then will they get title.

Either way, the seller will often ask the buyer to fill out an application, pass a credit check, and make a down payment. The seller may also ask for certain requirements, such as the relationship to the house. Alternatively, they may insist that the buyer retain the right to foreclose on the property in the event of a default.

If both parties agree, you must sign a promissory note containing the terms of the loan. They then apply for a secured loan (or deed of trust in some states) from the local state records office.