October 17, 2023
by Evin Bachelor
Everyone applying for a loan knows that the low-interest rate loans we have become accustomed to may be a thing of the past, at least for now. This has meant increased curiosity about alternative financing, including seller-financed deals.
The idea is simple: the seller receives principal and interest payments from the purchaser over a set term of years rather than all at once, and the purchaser does not have to obtain a bank loan.
The two main ways this occurs for real estate are a promissory note and mortgage, and a land installment contract:
1. Promissory note and mortgage. A promissory note is simply a promise by someone to pay their lender (in our case, the seller) a sum of money. The note explains the principal balance, frequency of payments, interest rate, identity of the parties, what happens upon a missed payment and other payment details.
A default on a promissory note without collateral would be considered unsecured. Here, the lender’s main avenue of collecting following a default would be to sue the person who made the promise and hope they have assets to collect against. Unless the note specifies otherwise, the lender would be paying his or her attorney fees to sue the borrower.
Enter the mortgage. The mortgage secures the promissory note by attaching the promise to pay to collateral (typically the real estate being purchased). With a mortgage, the lender can foreclose on the property in the event of a default on the promissory note.
With a promissory note and mortgage, the person who made the promise is the legal owner of the real estate as evidenced by deed.
2. Land installment contract. A true land installment contract is a legal contract entered into by a seller (vendor) and a purchaser (vendee). The contract calls for payments over time, much like a promissory note, and grants certain rights and responsibilities of possession to the vendee. Typically, the vendee is responsible for property taxes, insurance and utilities as if the vendee were the legal owner.
A key difference is the deed to the real estate is not delivered when the contract is signed, and therefore ownership is not transferred until the final payment. Out of fairness, Ohio has adopted the public policy that a land installment contract under which more than 20% of the payments have been completed shall be treated the same as if the vendee were the legal owner and the vendor merely possessed a mortgage. This means to terminate the contract after this threshold, the vendor would have to initiate a foreclosure action.
Benefits, drawbacks for sellers
One possible financial benefit for the seller includes spreading taxes over multiple years, rather than having to claim a large gain in one tax year. One possible nonfinancial benefit for the seller is knowing he or she is helping out the purchaser by providing better financing terms than the purchaser could receive elsewhere.
With seller-financed deals, the phrase “seller beware” applies. If the purchaser defaults, the seller must enforce its rights under the legal documents, which could mean filing for a foreclosure. This is a very technical, legal process that few attorneys facilitate, which means it can be expensive for a lender to pursue.
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