Seller Financing

Seller financing occurs when a seller of real estate lends a buyer part or all of the purchase price and lets the buyer make payments over time. At closing, the buyer usually signs a promissory note and a deed of trust or a mortgage. If the buyer does not make the required payments, seller can foreclose and take the property back.

If a seller agrees to finance the sale, the earnest money agreement should require the buyer to provide a good credit report and copies of income tax returns and bank statements. When the seller receives the credit history of the buyer, the seller should have the right to either cancel the sale because of bad credit or go ahead with the sale.

In the earnest money agreement, the seller must attach a copy of the promissory note and deed of trust to be signed at closing. If seller approves "unfavorable" forms of the promissory note and deed of trust as part of the earnest money agreement, seller cannot later require buyer to change at closing.

If the seller already has a loan on the property which the seller does not want to pay in full, the seller should be sure the property is not subject to a "due-on-sale clause" which allows the lender to call seller's loan due if the property is sold. Most bank deeds of trust contain such provisions. Sellers with such deeds of trust cannot do seller financing without their lender's consent. Neither can a seller avoid a due-on-sale clause by granting a lease with an option to purchase to a buyer.

Sellers must be especially careful about "second deeds of trust." This occurs when buyer borrows part of the purchase price from a bank. The bank takes a "first deed of trust" to secure its loan. Seller receives a "second deed of trust" junior to the first deed of trust. If buyer stops payments to the bank, the bank could foreclose its "first deed of trust." This cancels the seller's second deed of trust from title. The bank has no obligation to pay the seller the balance due on seller's second deed of trust.

Another problem can occur if the buyer sells the property and seller's deed of trust does not have a due-on-sale clause: then seller has to accept monthly payments from the new owner. Also, buyers may damage the property by cutting timber or botching a remodel job, so that the property is worth less than the loan balance. Then when the seller forecloses, the seller takes back a piece of property worth less than the loan.