Considering Providing Seller Financing – Do Your Due Diligence!

As a seller of a commercial or residential property, there are many things to consider as you go through the sales process and review of offers on the property. In some cases, those offers could contain proposals from buyers that are asking for seller financing – i.e. for the seller to convey title but carry a portion of the purchase price after the sale.

Before accepting a proposal like this, it is imperative to do your due diligence and fully understand why the potential buyer is unable to obtain traditional financing. The seller should conduct the same or similar due diligence as a traditional lender. Completing a full background check of the buyer, confirming adequate title insurance and necessary endorsements, confirming certificates of property insurance, confirming leases, rents, and security deposits, and ensuring that you have adequate security in the future and having the proper terms is critical to making sure seller financing makes sense for you and the property you are selling.

Why Seller Financing?

There are many reasons that buyers ask for seller financing. It might be a family member or another close friend that is unable to qualify for traditional financing and seller financing is the only option to be able to purchase the property. Other times it is the property type, such as agriculture land, that might make traditional financing unavailable or it may just be an easier path to a sale to have seller financing as an option.

More often than not, and even in the previously mentioned situations, the primary issue is the buyer is having trouble accessing traditional financing via a bank or other financial institution.

Requests for Seller financing are not deal breakers, but because of the risk, future considerations, and continuing relationship under seller-financed deals, it should change your thinking as the seller to behave like a bank and understand the potential risk that comes with seller financing.

What to Do When Considering Seller Financing

When considering providing seller financing, put yourselves in the shoes of a lender. This can mean thinking about carrying this loan for short or longer periods of five or more years with the possibility that you might not see full repayment after conveying title. Should the buyer not fulfill the terms of the loan, it can be an expensive and time-consuming process to foreclose a deed of trust. Even then, there’s no guarantee you will get all of the money you are due.

If you are considering providing seller financing, get in touch with legal counsel that can help you through this process. At Holmquist + Gardiner we have a team that has extensive real estate experience that can advise you on the process and best way forward.

Once you’ve obtained counsel, the first step is to understand why the buyer is not able to secure traditional financing. Even if another buyer offers a lower purchase price with traditional financing, it removes the risk and liabilities you will face if you provide seller financing. 

If they cannot access traditional financing, ask yourself what terms would make the deal the most viable for you? It’s important here to not just think of yourself as equal to a bank that does these transactions daily. You have to think through closing costs at the time of sale, taxes, commissions that need to be paid and any financing you yourself might need to pay off. Make sure your terms will cover all of the existing mortgage and debts before moving forward.

Also, since you are not a bank, you may not want to charge the same interest rate that’s available to all consumers. As previously mentioned, banks do this daily and are looking for additional deals over time. You are, likely, only working with this transaction. You should consider a higher interest rate and also higher down payment rates than traditional banks to ensure the deal accounts for the risk you are taking on.

Once you’ve settled on the terms, your counsel will help you secure a title report. This will provide a clear picture of title to ensure your security position is adequately protected. It is also highly recommended that a seller has the buyer pay for a lenders policy that is a guarantee of title insurance. This ensures that you will have a first position security interest on the property moving forward.

Your counsel should also ensure that you have critical protections such as a “no further encumbrances” clause and a “due on sale” clause in your financing documents. This ensures you have a high level of security in the property and prevents any additional sales/transfers without the seller being paid in full.

Finally, make sure your financing documents (typically a promissory note and deed of trust) are properly drafted, executed and recorded in the county in which the property is located. This spells out the terms of the seller financing and provides notice to all third-parties that you have a security interest in the property. 

What’s the Goal of Seller Financing as the Seller?

It’s great to be able to offer seller financing to help someone purchase your property, as long as you’ve done your homework. For sellers, the goal should be only using seller financing if the risks are fully understood, and it makes financial sense.   

Recognize that this is going to be an ongoing relationship. You won’t be able to just walk away once the terms are sealed. You still have a continuing interest in the property until the note is paid off in full. This means being proactive in checking in with the borrower regarding the status of insurance, maintenance of the property, and payment of taxes. Make sure you do everything to protect yourself legally and financially before agreeing to move forward on a seller financing deal.

If you have additional questions or want to talk about a seller-financed deal, please contact our team and we’d be glad to provide assistance.