Seller Financing

A source of credit for a real property buyer is often the seller. If the seller is willing to take back a mortgage as part or full payment of the purchase price, it is referred to as seller
financing. This type of financing is used when:

1. Third-party mortgage financing is too expensive or unavailable.
2. The buyer does not qualify for long-term mortgage credit because of a low down payment or difficulty meeting monthly payments.
3. The seller desires to take advantage of the installment method of reporting the gain from the sale.
4. The seller desires to artificially raise the price of the property by offering a lower-than market interest rate on the mortgage, thereby creating more capital gains and less interest or ordinary income.

Any mortgage given by a buyer to the seller to secure payment of all or part of the purchase price of a property is usually called a purchase-money mortgage. It can be a first mortgage, which might be the case if the seller is providing all of the financing necessary to consummate the transaction. It also could take the form of a second mortgage that is provided by the seller and is used to bridge the gap between an available first mortgage and the buyer’s down payment. As such, it must be differentiated from mortgages given to secure a loan from a third party for the purchase of the property. The third-party lender (e.g., a financial institution) will normally want its mortgage to be a first mortgage. Thus, the purchase-money mortgage must either be recorded after the third-party loan or contain a subordination clause, as defined earlier.

Land Contracts

One form of financing real estate that has been widely used over the years is commonly referred to as a land contract. The term land contract has a variety of aliases, including real estate contract, installment sales contract, agreement to convey, and contract for deed. As the last term implies, the land contract seller promises to convey title at such time as the purchaser completes the performance of the obligation called for in the contract. Such performance usually means payment of the purchase price in stipulated installments, much the same way as under a note and mortgage. It should be emphasized that a land contract is not a mortgage. Under the land contract, the sellers retain the title in their name. The deed record shows that the sellers are still the owners of the property, but the land contract is supposed to tie their hands to make sure that the sellers or their assigns ultimately transfer title to the vendees or their heirs or assigns. The land contract may be used as a substitute for a purchase-money mortgage and would normally not be preferred if the latter were available. However, in cases where there is no down payment or a small down payment, and a very long period of time during which a buyer must make periodic payments to the seller, sellers of land may refuse to give a deed and take back a mortgage until a very substantial part of the purchase price has been paid.

Several points of comparison exist between purchase-money mortgages and land contracts. A land contract buyer does not have title to the property and therefore cannot control whether the property will be mortgaged subsequent to the execution of the land contract or be made subject to covenants, easements, or mechanics’ liens in the future by the contract seller. Most land contracts contain a clause allowing the seller to mortgage property up to an amount equal to the buyer’s indebtedness to the seller. The buyer would have this protection if mortgage financing were used because limits would be made explicit and the buyer would have title. Furthermore, the possibility of forfeiture of the land
contract interest may exist without any of the procedural protections afforded mortgages. It is suggested that all such points of comparison should be considered in making the decision whether to buy or sell on land contract or to obtain mortgage financing. In general, land contracts are used in many of the same situations as purchase-money mortgages (e.g., where the buyer has difficulty obtaining third-party financing).

Recording of Land Contracts

State laws provide for the recording of conveyances of land and instruments affecting title. Land contracts generally are considered instruments affecting title and are consequently admissible to record. Recording land contracts is not essential to their validity; it merely gives notice of their existence to third parties.

Source: Brueggeman, William B (2010-02-12). Real Estate Finance & Investments (Real Estate Finance and Investments).