One of our seasoned listing agents just received a seller-financing request that is so crazy, brazen, risky, and awful – that I had to blog about it.
Fannie Mae and Freddie Mac guarantee mortgage financing scenarios that no commercial bank would ever offer.
These include low-down-payment scenarios (10% or less), weak-credit scenarios (scores under 680), and high-debt-ratio scenarios.
This enables cash-starved and less-established borrowers to buy homes – but it also, of course, artificially inflates demand and housing prices (a topic for another blog).
My point is this: If a bank won’t embrace certain financing scenarios because they are too risky without a Fannie/Freddie guarantee, a seller considering seller-financing should not go near a scenario a bank would not embrace.
And if a seller sees a seller-financing scenario that even Fannie and Freddie won’t embrace, sellers should run like hell…
I am blogging about this for several reasons:
(1) The brazenness of the offer I saw yesterday is fascinating.
(2) These seller-financing requests surface much more often in soft markets – when buyers hope desperate sellers will accept extremely risky financing if it comes with a higher price.
(3) It gives me a good opportunity to discuss when sellers should accept seller-financing.
The Seller-Financing Offer Looked Like This:
A. The buyer was an investor, not an owner-occupant (red flag #1) – offering $289,000 for a $300,000 listing.
B. The buyer offered to pay off the buyer’s $190,000 first mortgage with a new DSCR first mortgage.
C. The buyer then asked the seller to carry a $74,000 second mortgage at 2% (WAY below the market rate)
D. The buyer is only putting $25,000 of cash into the deal (less than 9%).
The seller was tempted because this was the highest offer she had received in a soft TX submarket.
But – she should run away – full speed and screaming.
A. Fannie Mae itself won’t touch investor financing unless there is at least 20% to 25% down, and a commercial bank would not touch this deal with less than 30% down
- Sellers are less sophisticated than banks and have a much harder time foreclosing, so they should be requiring higher down payments, not lower ones.
B. There is no indication regarding the credit quality of the buyer.
C. The second mortgage is way below market rate and far too risky (2nd mortgage lenders are often left holding very large bags when there is a foreclosure).
D. Buyers of this nature walk away from obligations in a red-hot minute – if home values fall or cash runs out.
E. The seller is taking way too little cash from the deal.
What Should Sellers Look for When Considering Seller-Financing?
Mostly the exit door.
If a buyer cannot obtain conventional or non-QM financing, they likely represent too much risk for sellers who are not sophisticated lenders.
Every time soft markets surface, going back over 30 years now, I see sellers accept weak seller-financing offers in an effort to garner a higher price. And – I have seen far too many of those deals go south later on.
If sellers want to carry a mortgage for the guaranteed yield, or because they want to help someone they know and trust – so much the better.
But, they should know their risks – and ensure there is a sufficient down payment (skin in the game) from the buyer.
There is a reason banks require at least 20% down when Fannie and Freddie are not backing the loan: banks have learned from experience that foreclosure risk is far higher when down payments fall below 20%.
In addition, sellers should ask a friendly mortgage lender to review the buyer’s credit file to ensure their income, assets, and credit are sufficient.
