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Definition: Seller Financing
Seller financing is a type of a loan the seller of a real estate provides to the buyer. It is also commonly known as purchase-money mortgage. This type of financial instrument is usually used by the buyer in times of tight credit market. Seller financing serves as an incentive for the buyer to purchase the property.
It is also a beneficial tool for the buyer when he is unable to obtain a loan from the bank. The buyer usually has to pay a down payment to the seller followed by timely payment of instalments at the specified interest rate. The seller may provide this loan based on the credit worthiness of the buyer or the ability to pay the mortgage. In cases where the buyer is unable to pay back the loan amount, the property will be repossessed by the seller, as a bank would have done.
The seller can minimise his risks by taking right precautionary steps. A legal purchase agreement is drawn up, signed by both parties, in order to protect the rights of both, the seller and the buyer. The terms, such as the selling price, down payment, interest rate, repayment schedule, etc. are negotiable. The seller will be in the best position to offer seller financing when the house is free of mortgage i.e. when the mortgage is paid off or can be paid off with the down payment amount.
Instead of giving cash, (as in case of banks), the seller provides credit to the buyer to purchase the property, less the down payment. The loans provided are usually short term- a typical deal might be for a loan to be amortized over 30 years but with a balloon payment due in five years. (Balloon payment means the repayment of the principal amount made at the end of the loan period.) Thus it can be assumed that within a few years, the financial situation of the buyer will have improved so that he can refinance with a traditional lender.