Why seller-financing isn't the right strategy for this housing market

The good news for prospective home buyers is this: Interest rates are extraordinarily low, there's a lot of housing inventory to choose from, prices have come down and there's even an $8,000 tax credit available to first-timers.

The bad news is that as good mortgage rates are, getting a mortgage is a lot tougher than it used to be. Higher credit scores are required and the days of stated income loans are over. Unless you qualify for an FHA loan, there's also a good chance you'll need a 20% down payment.

Enter seller financing: If you can't qualify for a traditional mortgage, you may be able to find a seller willing to lend you the money to buy his house -- or at least carry a portion of the purchase price as a loan. This can help you avoid strict underwriting standards and it seems like a win-win: You get a house, they get a buyer, and you get financing and they get a stream of interest-bearing income.

SFGate.com recently reported that more sellers in that San Francisco area are offering seller-financing as a way to make their homes stand out in a very, very crowded market.

But for home buyers, there are two major reasons why seller financing is unlikely to be a good option:
  1. Only sellers in strong financial positions will be able to offer you a loan to buy their homes. People who need cash now won't be able to work with you on financing, and that eliminates short sales, foreclosures and otherwise distressed home owners from the mix. Families who are "trading up" to bigger homes also won't be able to help because they need the cash for their new place. Eliminating all those categories of people eliminates a huge chunk of the available housing stock -- and especially eliminates the distressed sellers who will offer the best bargains.
  2. With interest rates this low, you want to lock in a long-term rate. Some sellers might be able to offer a 5-year loan with the hope that you'll refinance into a conventional mortgage at that point but if interest rates soar as they eventually will, you could find yourself in much the same position that people who bought homes with adjustable-rate mortgages are in now.
For those two reasons, home buyers shouldn't get too excited about the prospect of seller-financing. There are government programs available to help buyers without a lot of capital to make a down payment and FHA loans also don't require particularly good credit. If you're unable to finance a home purchase through the conventional channels, you're probably better off cutting your expenses, building up your credit, saving money and waiting to buy.
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