Seller financing, also called “owner financing” or a “land contract,” is when the home seller provides a loan to the buyer.
Seller financing can help a buyer move from renter to homeowner without the need to meet standard mortgage guidelines. It’s a popular option for borrowers who struggle to get a mortgage through a traditional lender. Though seller financing will help borrowers at the time of their purchase, they may be able to get more favorable loan terms and interest rates by refinancing after earning home equity.
Here’s everything you need to know about refinancing a seller-financed home.
Can You Refinance a Seller-Financed Home?
Yes, you can refinance a seller-financed home into a traditional mortgage. In fact, this is a common path for many buyers. Here’s how it works:
When you purchase a home through seller financing, the seller acts like a bank. You and the seller agree on the loan terms in a document called a promissory note. This note is your official loan agreement.
After making payments for a few years, the buyer builds up equity in the home. At that point, many buyers choose to refinance with a traditional lender. This allows them to pay off the remaining balance of the seller-financed loan—often through a balloon payment, which is a large, lump sum due at the end of the loan term.
However, it’s important to review your original agreement carefully. Some sellers include rules like prepayment penalties, which charge a fee if you pay off the loan too early. These terms are binding, so make sure you understand them before refinancing.
Most seller-financing deals are short-term (typically 5 to 10 years) so refinancing is expected and often necessary to avoid making a large balloon payment out of pocket.
In a refinance, your new lender issues a loan that pays off the seller. The seller is no longer the lender, and your new mortgage is now with the traditional lender.
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How to Refinance a Seller-Financed Home
Refinancing a seller-financed house is similar to refinancing any other mortgage. You need to set your expectations, apply with several lenders, and make sure you can pay any closing costs and fees. Here’s a step-by-step process:
Step 1: Review your current financing terms
Before diving into the refinancing process, carefully review the terms of your existing seller financing agreement. Take note of the repayment terms and any other conditions that may impact your decision to refinance. A savvy seller would have set a prepayment penalty in the loan agreement to ensure they still make a profit if the buyer decides to refinance early.
If you’re unsure about your loan agreement, consider hiring a real estate attorney. The intricacies of a seller-financed mortgage can take time to understand. Real estate attorneys will determine the necessary steps for you to take to properly refinance and identify any pitfalls along the way, such as prepayment penalties and any other special conditions.
Step 2: Apply with several lenders
Once you’re sure you’re ready to apply for a home loan, it’s time to compare lenders. Contact and compare several lenders to get better loan terms and mortgage rates.
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There will be a slight decrease in your credit score when you apply with the first lender, but subsequent inquiries won’t negatively affect your credit further.
Talk with each lender and make sure your goals align with what they can offer. Each lender should give you a Loan Estimate document with their loan details. Pay special attention to the closing costs and fees, as you’ll have to fit those into your budget. It’s time to move forward when you’re satisfied with a lender.
Step 3: Gather the necessary documents
Prepare the required documentation for the refinancing application. Refinance documents typically include proof of income, tax returns, bank statements, and details about the property.
Your lender will let you know which documents you need, and additional documentation may be needed compared to a traditional mortgage-to-mortgage refinance.
For example, since non-traditional financing isn’t always reported to credit agencies, your credit report may not include your history of on-time mortgage payments for your seller-financed loan. Therefore, you may need an additional bank statement as proof that payments were made regularly for the most recent 12 months.
Step 4: Appraisal and property valuation
The lender will typically conduct an appraisal or property valuation as part of the refinancing process. This step helps determine the home’s current market value, influencing the new loan terms.
The appraisal helps determine the Loan-to-Value Ratio (LTV), which is the ratio of the loan amount to the property’s appraised value. A higher appraised value can result in a lower LTV, potentially allowing you to qualify for a more favorable interest rate or terms.
Step 5: Underwriting and approval
Once the lender has all the necessary information, the application goes through the underwriting process, where they thoroughly review your financial history and the property’s value.
Your lender might contact you to ask for additional financial documents during this step. Respond promptly, as they can’t approve you before finishing the underwriting process.
Once everything meets the lender’s criteria, you’ll receive loan approval.
Step 6: Closing the refinance
Coordinate with the lender to schedule the closing. You’ll sign the new loan documents during the closing, and the new lender’s funds will pay off the existing seller financing. Make sure to notify the original seller-financer about the changes.
You’ll need to pay closing costs and fees in this step. After the closing, congratulations—you’ve refinanced your seller-financed home.
