Anyone interested in buying or selling real estate knows that interest rates have steadily risen during the last year and a half to reach the highest average rate this country has seen in decades. Higher interest rates pose obvious challenges for buyers requiring financing. Buyers will also notice that conventional lenders have significantly tightened underwriting standards, making it harder for many borrowers, who would have been approved in the past, to obtain a mortgage. In previous blogs, we have provided some advice to best protect Buyers and Sellers from risks associated with rising interest rates when drafting a residential real estate contract. In this blog, the focus will be on seller financing as a possible alternative to conventional financing, which may be attractive to Buyers who might have difficulty obtaining a conventional loan for various reasons.
Exploring Seller Financing as an Alternative
Seller financing is a means by which a Seller agrees to finance, or loan, a portion or all of the Buyer’s closing costs in exchange for the Buyer executing a note – often secured by a mortgage – guaranteeing repayment in accordance with agreed upon terms. In a sense, the Seller agrees to act as the Buyer’s lender. Like most lenders, the Seller has the right to collect payments and take the same actions a conventional lender would if the payments are not made as agreed in the note and mortgage.
Proper Drafting of Seller Financing in Residential Contracts
When the parties to a residential contract decide to include seller financing as part of their agreement, it is crucial to properly draft the contract to ensure adequate protection for both parties. Far too often we see the parties simply add language such as “the parties agree to seller financing in the amount of $__________.” For the reasons stated herein, that is simply not adequate to protect either Buyer or Seller. With this in mind, we suggest taking the following steps when drafting a contract including seller financing:
- When using either Far/Bar residential contract, select box 8(d), which is located in the “Financing” Section of the Contract. Section 8(d) simply states that the agreement includes a “purchase money note and mortgage to seller” and directs the parties to “see Rider C for terms.”
- Rider “C” refers to the FAR/Bar “Seller Financing” Rider, a copy of which should be available in any contract drafting software and should be used whenever seller financing is included as part of an agreement. It is important to note that simply checking box 8(d) it is not enough to make the contract contingent upon the parties agreeing to certain terms to be contained in the note and mortgage. To do so, box 19(C) must be checked to inform everyone on notice that there is a separate rider included and made part of the contract.
- The last step is properly filling out the Seller Financing Rider to accurately reflect the terms of the loan, such as maturity date, interest rate, date of payments, who will pay for the drafting of the note and mortgage, and more.
Exploring Other Alternatives: Private Financing and Borrowing from Individuals
Of course, seller financing is only an option if the Seller is willing to do so. So, this topic begs the question of what other alternatives there are out there if conventional lending and seller financing are not available. Private financing from a non-conventional lender is an option. Still, we encourage any buyer considering this option to do your homework and know exactly what you are getting into. Another option is borrowing money from an individual, such as a friend or family member, in exchange for said individual receiving a note and possibly a mortgage. When purchasing a primary residence, borrowing from an individual comes with serious risks and can be in violation of the Dodd-Frank Act, as discussed in previous blogs; so, if considering this alternative, we encourage you to consult with a real estate attorney before doing so.
If you have any questions regarding seller financing, financing alternatives, or any other real estate matters, we strongly encourage you to contact your local trusted real estate attorney.