The Wisdom of Seller Financing By June Fletcher Wall Street Journal 08-28-2009

The Wisdom of Seller Financing
By June Fletcher
The Wall Street Journal
August 28, 2009

Q. My house has been on the market for seven months. We got our first offer this week. It was for the full asking price, but the buyer wants us to finance the mortgage. The buyer says that he lost his job last year and had to file for bankruptcy, but now has found another job and is paying off his bills. Because of the bankruptcy, he can't get a traditional loan. He has offered to pay us a better interest rate than we could currently get on a certificate of deposit.

We own our current home free and clear and are planning to downsize. We have enough cash saved to buy a smaller home. But we're worried about lending to someone who has been through bankruptcy. Should we take this deal?

--Chicago

A. Because you're considering what most people would regard as a very risky proposition, I asked two Chicago attorneys who specialize in both bankruptcy and real estate, David Leibowitz and Stuart Swanson, to weigh in on your question. Surprisingly, both say this could be a fine deal for you—assuming the buyer is responsible and now financially stable.

Bankruptcy either wipes out debts or sets up a manageable repayment plan, so someone who has just undergone it is relieved of a lot of financial stress. But because a bankruptcy stays on a credit report for up to ten years, it can be difficult and frustrating for someone who has filed for it to get a loan from a traditional lender. A house-hunter who has paid his bills in the past but suffered a bankruptcy because of something beyond his control--in this case, job loss--is likely to be very loyal to anyone who gives him a second chance. "I would suspect this buyer would do everything possible to make sure the seller is paid," Mr. Swanson says.

Still, you can't take the buyer's word that the bankruptcy occurred just because he took a temporary financial hit. "You have to be skeptical," says Mr. Leibowitz. To get a full picture, he says, you should first ask the buyer to fill out a Uniform Residential Loan Application, which will detail his income, expenses and assets. Then, find out what type of bankruptcy was filed, and what the terms and requirements are. You can find this for a fee through PACER (Public Access to Court Electronic Records), a service of the United States Judiciary. (You also may want to check out his case at the United States Bankruptcy Court for Northern Illinois.) Finally, with the buyer's written permission, you should pull his current credit reports; you can get this information, as well as his eviction and criminal history, for a fee on the American Apartment Owners Association Web site.

Once you're satisfied that the buyer isn't a habitual deadbeat, Mr. Leibowitz says there are a few additional things you should do to protect yourself. One is to insist on a hefty down payment of at least 20%, which will give the buyer an economic incentive to keep payments current. Another is to consider giving a contract for deed, also known as a land contract, instead of a mortgage. (Here's a sample form.) A contract for deed only confers full ownership rights after the home is completely paid off, and makes it easier for you to reclaim your home if the buyer doesn't pay. (Here are details from Illinois Legal Aid on how to evict.)

Finally, if you are satisfied that the buyer is financially responsible, but you really don't want to play banker forever, you have two other options. You can give the buyer a lease-option for a few years--with part of the lease payment going towards the purchase of the home--until he can repair his credit sufficiently to take out a traditional mortgage. Or you can offer financing, accept the buyer's payments for a few months to establish that he's paying faithfully, and then sell the loan to a private investor.