A risky tactic when conventional mortgages are not an option
Sue and Douglas Reed knew no bank would give them a mortgage—not with a bankruptcy and two foreclosures fresh in their credit history. They turned to Hilarie Walters, whose childhood home on 15 acres in Marshall, Mich., had been on the market since 2009, a year after she inherited it. Walters agreed in December to sell the property to the Reeds for $105,000. She also consented to a risky payment plan that in effect makes her the couple's mortgage lender. "They're paying me interest every month, but I'd rather have the money and be done with it," says Walters, an unemployed single mother who is using their payments to cover the mortgage on her Battle Creek (Mich.) residence. "It does make me nervous."
Financing provided by sellers, popular in the 1980s when mortgage rates reached 18 percent, is making a comeback in markets such as Michigan that have been hit hard by foreclosures and where tightening lending standards and years of economic distress have drained the pool of creditworthy buyers. For a small but growing number of people, it's the only way to get a deal done. "Anytime the market is in this much trouble, people have to find ways to get it to function," says Dennis Capozza, a professor of finance at the University of Michigan in Ann Arbor. Capozza has direct experience with seller financing: He purchased a friend's foreclosed home a couple of years ago and then allowed him to buy it back in installments.
Last year 52,991 U.S. homes were purchased with owner financing, up 56 percent from 2008, according to Realtors Property Resource, citing data collected from county record offices. Such deals accounted for 1.5 percent of all transactions in 2010. Michigan, which has a 10.3 percent unemployment rate, leads the nation with about 1,600 home listings that advertise seller financing, followed by Florida, Ohio, California, Wisconsin, Minnesota, and Texas, according to property website Trulia.
The risks in such deals are significant for both buyer and seller, says Jason P. Hoffman, a Faribault (Minn.) real estate attorney. "Each of them is seeking an advantage in an otherwise difficult situation, and they're hoping everything will work out as envisioned," Hoffman says. "It's an act of faith."
The Reeds, who put $25,000 down, make monthly payments of $565, reflecting a 7 percent interest rate, with the full balance due in five years. "This is the American dream, and we're going for it no matter what," says Sue, 56, who sells snacks from a trailer at estate auctions and going-out-of-business sales. "We'll either make it or it will break us."
The riskiest deals involve sellers who have bank loans on the properties, Hoffman says. Most mortgages contain a "due on sale clause," meaning the lender can call the loan if the home is transferred. While community banks sometimes grant exceptions, many homeowners take their chances, hoping lenders won't ask questions as long as the payments stream in, he says.
Some investors see seller financing as a marketing tool. Mark Cook, 30, a real estate agent in Lake City, Fla., says he sees an untapped market in people who have had their credit ruined by a foreclosure or short sale. Cook is working with a Canadian investor who bought and renovated four homes in Florida's Cape Coral and Fort Myers areas since September, selling them to buyers who needed financing. One more is for sale now, another is under renovation, and they have contracts to buy another handful of homes.
Cook markets homes to buyers with foreclosures in their credit history, as well as second-home purchasers and self-employed borrowers who don't show enough income on their tax returns to qualify for traditional financing, he says. He offers an interest rate of 9.95 percent and a balloon payment after seven years to buyers who can put down 20 percent in cash. "We are advertising in markets that are cheap, and we're satisfying the consumer's appetite for a bargain," Cook says. "Assuming you're not creditworthy and have cash, we are your avenue for buying a home."
Rebecca Hill, a 33-year-old high school science teacher, and her fiancé, Nicholas Lehman, bought an almost 2,000-square-foot house in Cape Coral through Cook for $107,000 on May 4. Her credit was damaged a year ago when her ex-husband lost a home they had purchased together in foreclosure, according to Hill. While they paid a premium for a seller-financed home, the monthly mortgage costs are $175 less than the rent they previously paid for a unit half the size, she says. "If I wait for my credit to be restored and then purchase, I'm not going to get a $107,000 four-bedroom home," Hill says. "That's not going to exist anymore."
The bottom line: In 2010, almost 53,000 homes were purchased in the U.S. with owner financing—sales that might not have happened otherwise.