The current real estate market has brought about many interesting, but not entirely new, scenarios. Although the market may currently favor buyers, conventional financing does not. As a result of the changing economy, the “mortgage crisis,” and an increase in the number of foreclosures, many lenders have tightened their lending policies. Many brokers may experience this tightening the hard way – when buyers don’t qualify for conventional financing on the properties they wish to purchase.
This article will discuss ways in which buyers and sellers can still close a deal despite a buyer’s inability to qualify for conventional financing. In addition, this article will discuss a broker’s role in facilitating such alternatives to conventional financing, and how a broker can ensure that he or she will still earn a commission on a deal.
There are many reasons a buyer may not qualify for financing. First, the buyer may not have a credit history of sufficient length. Second, the buyer may not have enough job history. And third, the buyer may not have enough funds to pay a down payment or closing costs.
In a situation in which a buyer learns he or she does not qualify for conventional financing for a home, the buyer and seller often part ways and the listing broker continues to list the property on behalf of the seller. However, savvy brokers may try to keep the deal together by encouraging the parties to explore alternative means of closing the deal. For instance, perhaps the seller is in a position to sell the home to the buyer on contract. The parties may not have considered alternatives to conventional financing, and the seller may be amenable to working with the buyer to close the deal.
One way in which a non-qualifying buyer may be able to purchase a home is through seller financing by way of either a trust deed and note or contract of sale. A seller may opt to finance a buyer’s purchase for many reasons. For instance, perhaps the buyer is financially secure, but does not have a job history of sufficient length to qualify for conventional financing. Or perhaps the seller is desperate to sell the home, and is satisfied that the home will have enough equity to secure seller’s financing of buyer’s purchase. Regardless of reason, seller financing can be a desirable option for many, particularly given that the seller may have adequate remedies available in the event the buyer defaults on the seller financing.
Two ways in which sellers and buyers document a seller’s financing of a buyer’s purchase is through a trust deed and note or through a contract of sale. There are good reasons for each type of documentation based on cost of drafting the document(s), the remedies available to the seller, and the speed in exercising the seller’s remedies. For instance, a trust deed and note calls for a transfer of the deed to the property from seller to buyer at the time the trust deed and note are executed and recorded. A contract of sale, however, does not call for a transfer of the deed until a future time, typically once the buyer has paid off the entire contract balance. For this reason, a contract of sale will give the seller greater control over the property throughout the duration of the contract, and will entitle the seller to seek the buyer’s forfeiture of the property in the event of a default. Both a trust deed and note and a contract of sale will entitle a seller to foreclose on the property in addition to seeking other remedies.
There are issues that sellers and their brokers should be aware of when a seller is considering financing a buyer’s purchase of his or her property. First, the seller should review the terms of his or her underlying loan(s) on the property in order to determine whether there is a due on sale clause. Many lenders will require a property owner to obtain consent in order to transfer any interest in the property to a third party. Otherwise, the lender may reserve the right to call the entire loan due, thereby requiring the seller to either seek another source of financing to pay off the lender, or pay the remaining loan balance off with available cash. In some instances, a seller may opt to finance a buyer’s purchase without seeking consent from his or her lender, thereby taking the risk that the lender could find out that the seller transferred his or her interest in the property, and require the seller to pay off the loan in full.
Second, a seller should determine whether he or she will allow the buyer to transfer his or her rights in the property during the duration of the seller’s financing. A seller may not want the buyer to have the ability to transfer any interest in the property, as the seller wants to ensure that the buyer is still on the hook for his or her entire obligation. In addition, a buyer’s transfer of an interest in the property could result in additional risk to the seller, as the new occupant or owner of the property may not take care of the property, or be financially responsible.
Third, a seller should determine whether he or she will allow the buyer to borrow additional funds on the property from third parties, and if so, whether the seller will subordinate his or her interest to that of an outside lender. Such subordination will undoubtedly reduce seller’s control over the property and his or her secured position, in that the buyer may borrow more than the value of the property, may borrow on unfavorable terms (i.e. balloon payments and pre-payment penalties), or may default on the financing. In addition, the buyer may have less motivation to satisfy his or her obligations with respect to the property because the buyer does not have a significant financial investment in it.
Another way in which a non-qualifying buyer may be able to purchase a home is through a lease option. Although a lease option grants a buyer rights that are initially different from a regular purchase, the buyer will have the ability to occupy the property, and then purchase the property at a later time when the buyer will perhaps be able to obtain conventional financing. This arrangement allows the parties to keep a deal together until the buyer can qualify for financing.
There are many issues that sellers and their brokers should consider with regard to lease options. For instance, is lender consent required before the seller can enter into the lease option? The seller’s loan terms may include a due on sale clause, and some lenders may consider a lease option a transfer of interest in the property. Brokers should advise sellers who are considering entering into lease options that they should ensure their loan terms do not prohibit such a transaction. Sellers may also want to consider how to protect themselves during the term of the lease and option period. Many buyers and sellers erroneously assume that a lease option buyer must take care of the property. However, landlord tenant laws apply to a lease option, and the seller will be responsible for complying with such laws. As a result, sellers should seek careful drafting of each party’s responsibilities within the lease option so as not to violate landlord tenant laws. Sellers may protect themselves in other ways, notwithstanding landlord tenant laws. For instance, a seller may require the purchase price for the property to be increased by any uninsured damage to the property, certain significant repairs, or property taxes paid by the seller on the property. A seller may also want to require the buyer to pay all property taxes on the property, and maintain a minimum amount of insurance coverage on the property.
As with anything outside of the scope of a real estate licensee’s work, buyers and sellers should be advised to seek legal counsel in drafting a trust deed and note, contract of sale or lease option. Although the parties may be able to purchase generic legal forms, such forms may not fully protect the parties. For that reason, brokers would be well advised to defer to legal advisors as to the adequacy of generic legal forms in protecting the parties to a transaction.
The benefit to brokers of their clients entering into alternative financing arrangements is that they will earn commissions on deals that otherwise would’ve gone away. As with any standard transaction, brokers should consider how and when commissions will be paid on transactions involving seller financing or lease options. Transactions involving seller financing may close in a similar way to those involving conventional financing. For those transactions, a broker would be paid a commission through closing.
However, a broker’s commission for a lease option may be negotiated and paid in a different way. First and foremost, a listing broker should discuss with the seller at the time of the listing what commission will be paid in the event the seller decides to enter into a lease option. Although this conversation may not be necessary in a healthy real estate market, alternative means of selling property are becoming increasingly common. Upon discussing the matter with the seller, a listing broker may want to include language in a listing agreement with the seller that covers the amount of commission that will be paid and by when in the event the seller enters into a lease option. In addition, the listing broker should state in the RMLS® listing the method by which the commission will be split in the event of a lease option.
The good news is that a broker may be successful in keeping a deal together despite a buyer’s inability to qualify for conventional financing. Although brokers may suggest that their clients consider seller financing or lease options, they should ensure that they don’t further involve themselves in drafting trust deeds and notes, contracts of sale, or lease options. Once their clients decide to move forward in a transaction involving seller financing or a lease option, brokers should advise them to seek assistance in drafting documents or determining the various tax and legal implications such arrangements may have on them.
This column contains general information only and must not be construed as legal advice.
Questions may be submitted directly to Maylie & Grayson by fax at (503) 775-1765,
by email at or by mail at 7959 SE Foster Road, Portland, Oregon 97206.