How to refinance a seller financed mortgage or property

[AJ Wong]

Oregon has been a fun state to invest. Lots of prime real estate and interesting/unique properties and opportunities and plenty of sellers with a low capital base, willing to owner finance on homes and land. 

I've purchased two properties personally utilizing seller financing and represented at least a handful of buyers acquire properties with private mortgages over the past five years including friends and family members. Recently, many of those seller carried mortgages are coming due and clients have reached out for either advice or recommendations for their refinance so I wanted to share a public synopsis of what's generally required by lenders and what to be prepared for. An exit strategy is advisable when considering an owner financed transaction with variable terms. 

What does a borrower need to provide a lender to refinance a owner financed mortgage note?

- Credit + Payment history. Ideally the payments and collection have been administered by a third party title company (part of original agreement) and they will have a full 12-24 month payment history. If the note has truly been administered between private parties the borrower will want to provide copies of the cancelled checks and a letter from the original note holder with a payment summary. Additionally borrowers could be asked to go once step further and provide copies of 12-24 month bank statements reflecting where the payments were withdrawn from. As always..the lender will require ALL PAGES. LoL

- Assets. Since we were discussing bank statements, most lenders will want to see the ability to repay (in additional to having paid on time) and usually a minimum of 3-6-12 months of equivalent mortgage payments in reserves. Optimally liquid reserves but often to include retirement accounts or other investment account statements.  

- Income. One advantage of seller carried mortgage or private notes is generally a reduction in income documentation. Not so with a conventional refinance. Borrowers will generally need to evidence 12-24 months of income and assets to cover the first few months of payments. Ideally a debt to income ratio of 40%+/- or better is optimal and work history should be stable. The mortgage market is healthy so there are several ways for income to be calculated including but not limited too: full income verification of two years W-2's or tax returns, 1-2 years of a 1099, average deposits of 12-24 months of personal or (50%) of business bank statements, an up to date P&L, DSCR (debt service coverage ratio) or rental income (investment properties only).

- Appraisal. Another advantage of seller carried financing are that sellers generally don't require an appraisal. Most conventional or Non-QM lenders will require an independent third part assessment but if the LTV is low enough and some compensating factors, occasionally for a rate and term refinance lenders will allow a drive by or 'online' appraisal. Costs for these services can vary by region and lender. Do not order an appraisal on your own, it will need to be ordered by the lender.

- Closing costs. Speaking of costs, seller carried financing generally does not come with lender fees. Typically just the cost of the title paperwork and administering the payments since there is no underwriting, processing or mortgage broker involved. The sellers interest is the interest and transactional convenience, when a lender is involved there are costs associated that can often be rolled back into the loan provided the loan to value (LTV) based off the appraisal is sufficient.

- Higher rates. If the borrower took a seller carried mortgage out in the past 3 years, there is a good chance that there current terms are lower than their proposed. Most of my clients have rates in the 4-7% range, some with interest only. With conventional rates in the 6.5-7% range on a primary home, payment shock can be offset by exploring extended amortization schedules such as 40 year or 10/30 Interest only loans. The first ten years are interest only (borrowers can still add principal payments) and at the end of the term the mortgage converts to a twenty year fixed mortgage at the same rate. Caution that these repayments generally cost more in the long run and the strategy would be to refinance again in a more favorable interest rate environment. 

A refinance that only pays off the existing balance (plus any costs) is considered a rate and term refinance and should offer lower mortgage rates and costs due to simplicity. They can often be expedited in a couple of weeks depending on the appraisal and title efficiency. A cash out mortgage includes any capital to the borrower beyond the existing mortgage lien, such as funds to recuperate capital investment into the property or consolidation. 

We just helped a Florida client with a ballon coming due at the end of the year on a jumbo refi, the borrower had some payment shock so we structured a ten year interest only payment since they plan on relocating within the net 3-5 years. No prepayment penalty so if/when rates drop they can refinance at anytime. 

What are the best seller carried terms you've heard of? Mine is a mentor at the start of the pandemic in Ft Lauderdale. 20% down. 3% I/O for 5 years on a million dollar home, now worth at least double.