Refinancing a Seller-Financed Home After Your Credit Has Improved
Borrowers who don’t qualify for a regular mortgage have more options than they may realize. Instead of waiting a few years to repair a credit score or save more money for a down payment and possibly missing out on buying a home, seller financing can help them purchase a home.
Seller financing can help home buyers build equity and improve credit at the same time. After a year or so of making payments on time, they may be able to go to a bank and refinance the loan with better loan terms on a regular mortgage.
Seller financing, also called owner financing and a land contract, is when the home seller provides a loan to the buyer. The two may already have a professional relationship — with the seller as the landlord and the buyer the renting tenant — and seller financing can help a buyer move from renter to home owner without having to meet standard mortgage guidelines.'
But it can also lead to the loan being due quickly and can have poor terms for a buyer who may not have a good enough credit score or doesn’t make enough money to qualify for a traditional loan.
“Usually people get seller financing when they can’t qualify for typical financing,” says Heather McRae, a senior loan officer at Chicago Financial Services.
There are all kinds of mortgage loan options, but seller financing can have some of the worst repayment terms.
How to refinance
Refinancing a land contract can be a smart move for many reasons. Since a 30-year fixed rate mortgage is at least 20 years longer than a seller financed loan, they can get a better rate, terms and will have a lower monthly mortgage payment.
“Seller financing is just like any other lien on a property and can be paid off through a refinance,” McRae says.
A bank doesn’t care if someone has seller financing, she says. What it cares about is if a borrower’s credit score is improving, if they can afford the loan and the loan-to-value of the home, among other things.
Since non-traditional financing such as seller financing isn’t usually reported to credit agencies, making such payments on time may not show up on a credit report, she says. So a borrower will need a bank statement, for example, as proof that payments were made regularly for the most recent 12 months and on time.
“Lenders will also obtain an official payoff from the creditor, in this case the previous seller, which is customary with any loan to be paid off through the refinance,” McRae says.
A refinance can also be done with a “verification of mortgage” form that the private lender fills out to prove the homeowner has paid the mortgage, says Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage.”
A credit agency an also “rate” the mortgage by calling the private lender and verifying the payment history, Fleming says. The credit bureau can add it to the credit report.
Who might want seller financing
A renter may want to become a home owner for various reasons, including to get out of future rent increases. Buying a home from a landlord can be one solution, with the owner financing the loan, though usually at a higher interest rate than a traditional mortgage.
“Generally speaking, alternative financing is going to have a higher interest rate,” McRae says. “Because the person lending knows you’re in a bind.”
Here are some examples of when people might want to use seller financing:
- A veteran with a bankruptcy must wait two years to get a VA loan, McRae says.
- For others, a bankruptcy can mean waiting four years to get conventional financing for a home, she says.
- Having a mortgage in bankruptcy can require a seven-year wait to get other financing.
- FHA mortgages require three years to pass after a short sale before a new FHA mortgage is allowed.
- Poor credit.
- Difficulty proving income or low income.
- Job loss.
- The property is deemed unacceptable by a traditional lender.
Details of seller financing
Seller financing doesn’t mean the renter continues renting the home. They become the owner and are responsible for the same things other homeowners are: paying property taxes, insurance and maintenance, among other expenses.
They also keep any equity if the home is sold or refinanced, and a down payment won’t be needed for a loan refinancing if there is equity.
Seller financing contracts are often a five-year balloon mortgage, meaning they’re due in five years no matter how much the buyer has paid off. Some allow 10 years to be paid off. That’s a lot less time than a 30-year fixed mortgage.
“The balloons can be a trap for a buyer,” says Bruce Ailion, an attorney and a real estate agent at RE/MAX Town and Country in Atlanta.
For example, if a buyer puts down 20 percent on a home and it rises 20 percent in value in five years, they now have good equity in the property, Ailion says. But when the balloon comes due and the buyer can’t refinance, they could be foreclosed upon by the seller and the seller would get the equity.
Or the seller could double the interest rate and extend the loan for three years, Ailion says. “They can go to a hard money lender at probably triple the rate for a 1-2 year term. Balloons are bad ideas,” he says.
And if interest rates double in five years, the buyer might not qualify for the higher payment to pay off the balloon, he says.
If buying a home is more affordable than renting, then seller financing can be a good temporary solution if you don’t qualify for traditional financing. But once you improve your credit score or do whatever else it takes in a year or so to improve your finances, then refinancing may be your smartest option.