Real estate mortgage: Seller financing can work, but be sure everyone is on the same page
By: Mark Weisleder
As a result of further restrictions announced by CMHC regarding the total number of deals available for insurance, lenders may tighten up their qualification process, which may cause a slowdown in the market, if the number of potential buyers for a home is reduced. Is seller financing an option that could create a win-win situation for both home sellers and buyers?
Seller financing is when the seller offers to take back a loan secured by a mortgage for part of the sale price, which can be anywhere from 70 per cent-90 per cent of the sale price, depending on the deal that is negotiated. Why would a seller do this? The benefits to a seller doing this are as follows:
- They will likely get a higher price for their property;
- The deal can probably close faster;
- The interest rate payable on the mortgage will likely be more than they can earn in any bank investment;
- They will attract more potential buyers, as buyers will not have to pay any mortgage fees or the CMHC insurance premium, which can be an additional 2-3 per cent of the mortgage amount.
- If it is an investment property, the seller can likely defer some of any capital gain on the sale into the future, when the mortgage is in fact payable.
Why would a buyer pay more for a property or a higher interest rate?
- They don’t have to go through the same rigorous lender approval process, or pay the additional fees;
- They will likely be able to negotiate an open mortgage, with no prepayment penalties when they want to pay the mortgage back
It goes without saying that the seller must do a proper credit check on the buyer, to ensure that the buyer can make the mortgage payments. There is also a risk that the buyer will not make the payments. However, if this does happen, the seller will be able to very quickly step in and sell the property if default occurs, under the powers contained in the mortgage.
A further concern against seller financing is that it will likely not be an option if the seller has a mortgage on his property, as this mortgage must be paid off on closing. The seller may not have the extra money available to do this. Real estate agents have the power to negotiate seller financing terms in the real estate contract, on behalf of buyers and sellers, although the lawyers will prepare and register the documents on closing.
I would also advise sellers to be very cautious before accepting a second mortgage on your property. This is where a buyer obtains part of the financing from a third-party lender, for example equal to 70 per cent of the value of your home, and then asks the seller to take back a second mortgage for an additional 20 per cent of the price.
The risks here are much greater. If the buyer stops payments on the first mortgage, then the lender has the right to step in and sell the property. The seller will then have to make all the payments owing under the first mortgage before they can step in and sell the property under their second mortgage.
Some of the important terms to consider when you negotiate a seller take back mortgage are as follows:
- Ensure that post dated cheques or pre-authorized chequing is obtained for all payments to be made under the mortgage;
- Include a penalty if any payment is returned NSF, typically $100-$200;
- Insert a provision for payment to provide a mortgage statement for discharge purposes; typically $250 plus HST;
- Include a clause that at the option of the seller, the entire principal outstanding becomes due if the buyer sells the property at any time during the term of the mortgage;
- Determine whether the seller will accept partial payments of principal at any time during the term of the mortgage, with or without a penalty.
Seller financing can be an effective option for some buyers and sellers, provided that everyone is properly prepared in advance.
Mark Weisleder is a Toronto real estate lawyer.