Seller financing can be an advantage

Red for sale sign

Offering to finance the sale of your home can give you an advantage over other sellers in today's tough market.

It allows you to consider buyers who might have trouble getting a bank loan because they lack perfect credit, are self-employed or have a commission-based salary.

Seller financing works much like a bank loan -- only you're the bank.

The buyer gives you a down payment and agrees to make monthly payments over a set period, just like a regular mortgage.

Like a bank, you charge the buyer an interest rate for the loan.

For example, if a buyer put down $20,000 for your $150,000 home, you could charge interest on the remaining $130,000.

In many cases, private sellers can afford to charge less than banks, which recently have charged an average of 5.5% for typical fixed-rate loans and more than 7.0% for jumbo loans. That gives the buyer a break.

Each month, the mortgage payment gets sent to you, which provides you with a steady income source.

You don't need to have paid off your mortgage to offer seller financing. You can use a portion of the buyer's payments to keep your mortgage for the home current.

However, seller financing is not for everybody.

If you need the money from the sale of your home to purchase another one, it probably won't work for you.

Here are a few additional things to consider before handing over the keys to your home:

Don't finance anyone with subprime credit. Always obtain a credit report and credit score for potential buyers. Anything below 620 puts the potential buyer in the lowest credit category, and you don't want to go there for any reason.

Avoid buyers who are consistently late paying their bills. If your buyer has a credit score of 620 to 700, it's important to know why he or she has below-average credit. A buyer who defaulted on a couple of medical bills after an accident or illness is less of a risk than someone with a long history of not paying their credit card bills on time.

Require a 10% down payment. That's the absolute minimum you should obtain to protect the equity in your property, according to Bill Broadbent, author of Owner Will Carry: How to Take Back a Note or Mortgage Without Being Taken. The more the buyer puts down, the more that person risks -- and the less likely he or she will be to stiff you.

Consider other forms of equity. "There are things other than money that people can use as a down payment," Broadbent says. If, for example, someone owns a vacant lot, the equity in that land could be used.

Hire an attorney. Obviously, you'll need to get everything in writing -- legally enforceable writing. Don't try to do it yourself.

Have enough cash set aside in case you need to foreclose. If the buyer defaults, you'll have to foreclose to protect your interest in the deal, and that can be expensive. Broadbent estimates the minimum cost would be $1,500 to $2,000. It could be more if you didn't pay off your first mortgage before selling the home to a new buyer.

For example, say you still owe the bank $90,000 for your home, which is worth $150,000, and you're making monthly mortgage payments of about $700 based on a 6% loan.

If you offer financing to someone willing to buy your home for $150,000 with a cash down payment of $30,000, you'll carry a note for $120,000. That's what the buyer still owes you.

Charge the buyer slightly more interest than you're paying, and you can safely cover your monthly mortgage payments with the buyer's payments. Charging 7% interest would get you $850 a month.

If the buyer were to stop paying and require you to foreclose, you'd have to come up with an extra $700 a month for your mortgage payment or risk defaulting on your loan.