6 alternative arrangements between a seller and buyer
Types of seller financing to consider
- Conventional seller financing
- Land contract
- Purchase option
- Lease option
- Lease purchase
- Wrap mortgage
A conventional mortgage is the easiest way for most homebuyers and sellers to transfer property. It is contingent on a lot of factors, however, such as a steady income from the buyer and a problem-free home for the seller. If your circumstances as a seller or buyer are atypical — for example, you are selling a historic property with some structural damage or your prospective buyer has inconsistent income streams — working with a conventional mortgage lender can be all but impossible.
There are several alternative arrangements that home sellers and buyers can explore if the conditions of the sale do not meet standard lender requirements. These strategies are often riskier and more complex than a conventional mortgage, however.
These agreements hinge on each party holding up their end of the deal, so it is imperative to conduct the same due diligence that both the seller and buyer would complete in a typical home sale transaction — including a home inspection and appraisal, title check and policy and assessment of seller disclosures.
One important factor to remember before exploring alternative ways to sell is the due on sale clause. Most mortgages include this clause, which requires that the loan is paid in full to the lender before the home can be sold. Whether alternative methods violate a due on sale clause varies by state law. If you as the seller do not own your home free and clear, be sure to get the existing lender’s approval or work with a real estate attorney before proceeding.
Conventional seller financing
Seller financing can be used to describe different forms of financing arrangements independent of a lending organization where the home seller effectively acts as the mortgage lender. Purchase price and loan terms are agreed upon between the buyer and seller. The buyer makes a down payment, the deed is transferred to their name and the seller collects monthly payments plus interest on the home. Oftentimes, buyers refinance the agreement into a conventional mortgage after gaining their financial footing.
A land contract goes by many names, including an installment sale contract, land installment contract, contract for deed or contract for sale. It is a form of seller financing where the buyer doesn’t get the deed until the contract is paid in full. Instead, the buyer has equitable title to the property while making payments, which prohibits the seller from selling the home to another party.
The buyer and seller agree to the home purchase price, financing term, down payment, interest rate, monthly payments and who will cover maintenance, tax and insurance expenses. Typically, a balloon payment is due at the end of the financing term.
With a purchase option, the buyer pays a non-refundable option price for the exclusive right to purchase the home within a set term, usually one to three years. The buyer and seller then agree on a purchase price for the property, typically either a fixed amount or the future market value at term-end.
The buyer does not live in the home and is not obligated to purchase the property at the end of the purchase option term, either. They can let the option expire, sell the option to another party or buy it at the agreed-upon price.
Also known as a lease purchase, rent-to-own or lease-to-own arrangement, a lease option is similar to a purchase option, except the buyer lives in the home while paying rent to the seller. The buyer pays the seller a non-refundable option price for the right to purchase the home within a fixed period of years. They also agree upon a purchase price for the property.
The buyer then leases the home, paying rent to the seller directly. Part of the rental cost is applied toward the final purchase price of the home. While the buyer is not obligated to purchase the property at the end of the term, if they decide not to buy the home they forfeit the option price to the seller. The buyer cannot sell the lease option to another party without the seller’s approval.
A lease purchase takes the same arrangement as a lease option, but the borrower must buy the property at the end of the lease purchase term — usually by obtaining a mortgage. In addition to rent payments over the course of the lease purchase period, the buyer is responsible for maintenance, tax and insurance costs. The buyer cannot exit the deal unless they default or assign the lease to another party, with the approval of the seller.
A wrap or wraparound mortgage is when a loan is taken out on a home being financed by an existing mortgage. The seller acts as the second mortgage lender, and usually charges the buyer a higher interest rate than their existing mortgage. While the original mortgage retains the first lien position, the deed is transferred to the new owner.
Typically, wrap mortgages are only possible if the primary loan is assumable. Depending on your state, a wrap mortgage may not be considered a violation of the due on sale clause and you may not have to inform the existing mortgage lender that their loan is being wrapped. It is always wise to consult a real estate attorney, however