February 21, 2019

The two letters cited in this article were received the same week.

“I am about to buy a home and the seller is offering me a loan at an interest rate .5% lower than the bank’s rate. Should I take it?”

An offer of seller financing should put you on your guard.

Most cases of seller financing involve a prospective buyer willing to pay the ask price who does not meet standard qualification requirements. In such cases, the seller is a reluctant lender looking to realize a target price on the house. In the case at hand, however, a qualified borrower exists but the seller wants to make the loan anyway, even at a below-market rate. The question is, why?

The best case is that the seller views the mortgage as a good investment. The worst case is that the seller wants to be the lender in order to conceal one or more problems connected to the property -- mold, leaky roof, poor drainage, defective title, the list is endless -- that he knows will come to light if an outside lender is involved.

Unless the seller can document that he is a mortgage investor who owns multiple mortgages, the buyer should assume the worst. If he proceeds with the seller as the lender, he should protect himself in all of the following ways:

• Retain a real estate attorney. 

• Require the seller to accept home and termite inspections by experts selected by the buyer.                                                                          

If there is an existing mortgage on the property, require the seller to:

• Provide a current statement.

• Agree to a procedure where mortgage payments by the buyer are directed toward repayment of the existing mortgage.

• Agree to a procedure where the timely payment of property taxes and insurance is assured.

• Check whether a new title insurance policy is needed.

• Make sure the new mortgage is recorded.

If I was the buyer in this case, I would view a loan rate ½% below the market as not worth the hassle.

“What Interest Rate and Fees Should I Charge if I Want to Act as a Private Mortgage Lender?”

 It is not clear whether this would-be lender is a home seller asking about a single transaction, or is looking to go into business. As a seller focused on one deal, his major concerns should be:

• The sale price. He can afford to be generous on the interest rate and loan fees if the home price is favorable.

• The credit worthiness of the buyer. The seller should do a credit check, and verify income and employment, just as institutional lenders do.

• The risk features of the loan. When you are dependent on one loan, you want that loan to be well-secured, with the down payment especially important.

• The procedures to be used in paying taxes and insurance.

• Access to servicing software. You do not want to keep track of payments, balances, taxes, insurance and late charges on the backs of envelopes.

If the would-be lender who wrote me is looking to become a non-institutional source of mortgage loans for anyone, his problem is altogether different. An individual cannot lend in the market for qualified loans because they are not be authorized to deal with the Federal agencies, which dominate this major segment of the market. They could operate in the non-qualified loan market but to be competitive, they would have to bring a substantial organization and capital to the process. An individual with limited resources could operate only in the hard money market.

Hard-money lenders lend strictly on the value of the collateral. They require borrowers to put 30-35% down, and charge high interest rates with short terms. These lenders do not bother with income, employment, or credit reports. If borrowers cannot pay, the hard money lenders get their money back through foreclosure. Before the great depression of the 1930s, all mortgage lenders including the institutions were hard money lenders. Today, they are a very small part of the market.