Seller Financing Risk and Mitigation

In my last blog, I talked about the opportunity that the current economic climate provides for sellers who have equity in their property:

Opportunity for lucky sellers, who are fortunate enough to offer financing in a world where credit is tight and lenders are running scared. These sellers will have a bigger pool of potential buyers and command a HIGHER PRICE for the sale of their home in LESS TIME than the same seller down the street who cannot offer owner financing.

Oh, sure! There are risks, as in any investment. What are they? and how might a seller mitigate the risk?

First of course, is to realize that as a seller providing financing, you ARE the bank. So think like a bank would in qualifying your borrower for a loan. Do they have a reliable and verifiable source of income? Do they have a history of good income? Have they been employed in the same field for a number of years? What is their credit history and credit score? Yes, you should ask for and verify a credit report! If credit score is low, you may want to charge a higher interest rate and/or get more of a down payment and/or shorten the term of the loan.

But, you ask, what if they stop making payments?

Make sure that you have handled the financing in a businesslike way and that you have a written agreement that should include a promissory note, and a warranty deed on the property that has been recorded with the County. Your loan is a lien against the property, just like a conventional mortgage. Your written agreement will include an understanding about what happens in the event of a default.

Washington State is a non-judicial foreclosure state, which means that a lender can foreclose on the collateral (the property) in the event of a default without having to go to court. This means that the entire foreclosure process happens much more quickly (typically in about 120 days) and at much less cost. If your borrower misses a payment, hire a real estate attorney and have them foreclose on the property.

What if they trash the property when they leave, after defaulting?

Make sure you get a sufficient down payment up front to cover this possibility. Damages to the property are grounds for a court judgment that might allow you to garnish wages or recover your expenses in the future. You might also offer your soon-to-be-evicted tenant/borrower a partial refund if they leave quietly and leave the house in good order. Then you get the house back, get to keep all the funds already paid, and do it again.

In my next blog, I will cover the risks and mitigation suggestions for a private lender.