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The easiest way to explain how seller financing works is by way of example. This approach strips away all of the terminology and mathematics, leaving the stuff that matters.  Keep in mind that we protect the confidentiality of all of our clients, so we'll change their names below.

Note Creation

 

A few years ago, a client of ours, Mary, decided to put her house on the market. Mary and her Realtor tried many approaches: magazine ads, fresh cake at the open houses, even that new-fangled emerging technology called the Internet.

 

Eight months later, Mary meets a young executive, Bill. Bill and his family are moving to this area from the other side of the country. He and his wife absolutely love the house. One week later, they and Mary agree on a price of $140,000. Bill writes a deposit check for $5,000. He pledges a total down payment of $40,000.

 

Let's quickly review the basic mechanics of the normal real estate transaction with traditional financing. The buyer pays the seller a substantial down payment. The buyer then applies to a bank for a loan. If accepted, the bank pays the seller the rest of the money for the house, and the seller transfers the house to the buyer. At the same time, the buyer gives the bank a promissory note (an I.O.U.), which indicates that s/he will pay the bank every month for a given number of years.

 

The Realtor starts to arrange financing for the remaining $100,000, only to find out: uh, oh! ... This young executive, who previously had a salary in the mid six-figure range, recently left his employer to start his own consulting firm. Bill's wife and two kids were at the Airport Hotel waiting for the house to close.

 

Guess what! The bright young executive, even though financially quite capable, can't qualify for a mortgage.  He was new to this area and had no verifiable employment. Even with $40,000 down, no lender would qualify him. ... The sale started to crumble.

 

The Realtor then suggested to Mary that she offer seller financing.  After thinking about it, and all of the time and effort spent so far marketing her house, she reluctantly agreed. Mary got the $40,000 down payment, and she took back a mortgage note from Bill.  Bill and his wife promised to pay Mary an additional $100,000 principal over the next 15 years, at an interest rate of 10%.  Their monthly payment is $1,074.61.

Mary is happy – in January of '95, the house is finally sold.  Bill and his wife are happy – they finally left their hotel room and started to unpack all of those boxes. The Realtor is happy – she finally got paid for those eight months of work.

Here are the basic mechanics of seller financing. The buyer still pays the seller a substantial down payment.  The seller then accepts a loan from the buyer directly, and in exchange, transfers the house.  There's no bank, and the seller just takes back the promissory note instead of the full cash amount. The buyer is agreeing to pay the seller directly every month.

Note Basics

About 20% of the houses sold in the U.S. involve some form of seller financing; one in five mortgage notes created are privately held.

 

The legal contract containing the terms of the loan is called a promissory note.  It is also known as a mortgage note, a trust note, or a purchase money note.  It specifies the principal amount, the interest rate, and the timing of the payments.

 

The promissory note is collateralized, or secured, by a second document.

 

In the Western part of our country, we have trust deeds as collateral.  The payor is called the trustor, and the payee, of course, is called the beneficiary. (huh?) (There is a third party, called the trustee, who holds the deed to the house, and is bound to give it to the appropriate party, because there are only two possible outcomes to a promissory note.  Either the payor makes their payment each and every month, on time... or they don't.)

 

 

Article Courtesy of Note World   http://www.note.com/note