Wrap Your Head Around Seller Financing

Posted on Mar 30, 2023 by Scott MacPherson

As the economy grapples with a potential banking crisis, buyers are seeking ways to reduce interest rates and qualify for loans.  Some sellers are willing to take on a bit of risk to help these buyers purchase through seller financing. Although seller financing is rare, it has grown more common as the Fed continues to battle inflation and fewer buyers qualify for agency or conventional loans with tolerable terms.

Typically, a buyer would have sought out a loan through a third-party lender, pledging the property as security for the loan’s repayment. Under seller financing, the seller acts as a lender and typically owns the property outright or holds enough equity to pay off their existing loan at closing.

The benefits of seller financing for the buyer include shorter loan approval times and requirements; reduced interest rates in some cases; and lower closing costs. This setup also benefits sellers, allowing them to offload property to buyers that couldn’t purchase otherwise, and creates steady income from the buyer’s monthly mortgage payments.

Some drawbacks include less cash proceeds for sellers at closing; a continued connection to the property sold; and the seller also risks potential buyer default. In the event of a default, the seller may have to commence the foreclosure process which can be very complicated and expensive.

Here in Texas, to effectuate seller financing, the buyer signs a promissory note in seller’s favor providing specifics on loan repayment; and a Deed of Trust (much like a mortgage in other jurisdictions) granting rights to the seller in the property and laying out restrictions which the buyer must abide by during the term of the loan. The promissory note will also state the interest rate on the loan, and will likely include an amortization schedule listing all payments required until the loan’s maturity or payoff and any prepayment premium.  Some of these agreements may also require property taxes and insurance amounts be escrowed, and the dollar amount of insurance coverage that must be maintained by buyer to protect the property.

There are also those situations where the seller wants to offer financing to a buyer, but is unable to simultaneously pay off the seller’s mortgage. In those instances, the seller will have to ask their current lender’s permission to extend any financing to the buyer and to have it secured by the property. If lender approves, the seller can create a “wrap-around mortgage” or “carry-back loan”. Essentially the new financing is wrapping around, and not displacing, the current seller’s mortgage.  Under this setup, the buyer gets a mortgage from the seller, but the existing seller mortgage is left intact and specifically mentioned in the buyer’s deed of trust as a superior interest. The buyer then makes monthly mortgage payments to the seller, who then pays their own mortgage on the property.

The lender is unlikely to approve of a wrap-around mortgage upon a secured property unless the necessary protections for the lender are included in the new financing documents. This will ensure the lender’s interests have priority over any new lien.

This article only scratches the surface of seller financing. This type of financing has been uncommon until recently and is often complicated. If you are interested in seller financing or have questions please feel free to reach out to me at smacpherson@patellegal.com or (972) 435-4339.