Seller Financing. What it is and what it isn’t…
Seller financing IS NOT a loan. It is more accurately described as “the terms of the sale”. Many an Attorney, Realtor (and their Broker) will argue that it is indeed a loan. They are wrong. Let me explain.
First, let’s begin with a couple of definitions and descriptions.
- Purchase Money Mortgage: A mortgage pledging collateral (most usually the subject home) to secure a Purchase Money Note.
- Purchase Money Note: A Note promising payment (also commonly called a Note)
- Mortgage: A pledge of collateral (most usually the subject home) to secure a Note.
- Promissory Note: A note promising re-payment (also commonly called a Note)
The confusion centers on the Purchase Money Note and Promissory Note being used interchangeably. They are NOT the same.
Let’s walk through 2 transactions to illustrate the danger of interchanging the two:
Transaction 1: Buyer wants to buy home. Agreed upon price is $100,000. Buyer does not have $100,000 in bank account. Buyer goes to a bank (3rd party to the transaction) to get a loan. At closing, bank gives $100,000 to the Buyer; Buyer then gives the Seller $100,000, Seller then transfers to Buyer the Title/Deed to property. Buyer promises to re-pay the bank (see where this is going?) by signing a Promissory Note and also pledging the home as collateral (Mortgage) in the event he does not re-pay the bank.
Moral: The Buyer borrows (gets a loan) from a 3rd party (bank) to complete the transaction. With the loan, money (in this case $100,000) is exchanged.
Transaction 2: Buyer wants to buy home. Agreed upon price is $100,000. Seller agrees to the following terms: Seller financing at the rate of $1,000 per month for 100 months. At closing Seller transfers Title/Deed to Buyer, Buyer promises to pay (not “re-pay”) Seller via a Purchase Money Note. The Purchase Money Note is then secured by a Purchase Money Mortgage which pledges the home as collateral.
Question: How can you “re-pay” a Title/Deed transfer? Answer: You can’t. You can re-transfer the property, but you can’t re-pay a transfer of ownership. (It was a trick question). If your Attorney, CPA, Realtor, or brother-in-law can’t grasp this concept, get a better Attorney, CPA, Realtor or brother-in-law…
Moral: The Buyer and Seller transfer Title/Deed. What is exchanged is a promise to pay (not re-pay).
Subscribe to:
Post Comments (Atom)
Beautiful explanantion. This is a common misunderstanding, just as many do not understand the difference between the mortgage and the note. Most (not all) professionals have a tendency to interchange terms not to purposely confuse but from their own lack of understanding. Having an attorney, CPA, realtor or mortgage broker that is knowledgable is an important key to your purchase but also having one that is willing to learn and get the answers you desire is someone you want to have in your corner as well.
ReplyDelete