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When you sell a property with owner financing, one of the biggest advantages for you, as the seller, is that you can dictate and control many of the terms and conditions of the loan you set up.

This is a huge benefit, but only if you know how to wield this kind of power and what options you have on the table.

Why You Need Control in Seller Financing

Let's step back and acknowledge something.

When you give your buyers the option to purchase your property with seller financing, you're doing them a HUGE favor. This allows them to sidestep much of the time-wasting (and sometimes deal-killing) red tape that banks force their borrowers to go through.

Sometimes, seller financing is a borrower's only option because their bank doesn't like the property or the borrower's risk profile. And at other times, buyers will take you up on seller financing even if they have other options simply because they don't want to deal with banks.

RELATED: Seller Financing Masterclass Review

Don't get me wrong, working with a bank has advantages. Banks typically charge a lower interest rate and almost always allow for a longer amortization on their loans with no balloon payments. Banks have no problem letting their borrowers pay off loans over 15 to 30 years, but most sellers (including you) won't wait this long to get their money back.

But if you decide to offer this convenience to your borrowers, you'll want to know how to stack the cards in your favor so that you're compensated for the inconvenience of waiting longer to get your money. It's not just about getting a large enough down payment and high enough interest rate (although that is a huge part); it's also about having control.

The same applies when buying a property with seller financing. For a more comprehensive understanding of this financing model, read my blog post about seller financing terms that put buyers in control and compare those terms to the ones below.

Loan Terms That Put Sellers In Control

What terms can you include in your loan documents to keep yourself in the best possible position should your borrower ever decide to pay late or stop paying altogether?

Here are some of my favorite terms to include:

1. Remedies on Default

When drafting the remedies on default in your loan documents, from a seller's or lender's perspective, the goal is to create a set of tools that will give you the maximum control and flexibility to address any potential defaults. You'll want to make sure that if the worst-case scenario occurs, you'll be protected.

Here are some creative and strategic provisions that could be included to strengthen the seller's or lender's position:

Late Fees and Default Interest

This is a standard provision in pretty much any loan document template, but in case it's not obvious, I'll point out that you can implement higher interest rates and/or late fees after default. This is a good motivation for the borrower to make timely payments and compensate the lender for additional risk and costs associated with handling the default.

Acceleration Clause

Think of an acceleration clause as a safety net for the seller. It's like saying:

“Hey, if you don't follow the rules we agreed to, you'll have to pay off the entire loan now.”

Here's how a seller can make a really strong safety net with the acceleration clause:

1. Clear Rules: The seller should clearly define what counts as “breaking the rules” (otherwise known as being in default). This could be not paying on time, not keeping the property in good shape, not paying for insurance and taxes, or anything else you and the borrower agree on.
2. Warning: If the borrower ever violates the rules, the seller should give them a heads-up and specify what the problem is and how much time the buyer has to fix things before the seller asks for all the money back.
3. Legal Stuff: It's important to ensure everything in the clause follows the law and is fair. Sometimes, there are specific rules about how and when you can ask for all the money back.
4. Professional Help: It's important to talk to a lawyer who knows all about these things. They can ensure the clause is strong, fair, and follows the law.

By having a clear and fair acceleration clause, the seller can feel safer lending money and have a plan if things don't go as expected. It's all about making sure everyone knows the rules and what happens if they're not followed.

Define the Collateral

A huge part of what keeps the seller/lender safe in a seller-financed transaction is their collateral.

The collateral is whatever the lender can grab and take from the borrower if they stop paying.

In most of my seller-financed transactions, the collateral was the subject property. No more, no less.

If that borrower ever stopped paying, the only way I could make myself whole was to take the property back. That meant paying whatever costs, spending whatever time, and going through whatever channels were needed to regain control of the property.

The tricky thing about collateral is that it's not just about what the collateral is worth; it's also a matter of how much time it will take, how much money it will cost, and how easily it will be to get it back. Some states make this more difficult than others.

The key is to make sure the value of your collateral is more than enough to justify your efforts in taking it back. In other words, it should be worth well over the loan balance when you close the loan. This is known as the Loan-to-Value Ratio (LTV).

For example, if I'm selling a 10-acre parcel for $50,000, it's legitimately worth $50,000, and the borrower puts down $10,000 at closing with a $40,000 loan, my loan-to-value ratio is 80% (40,000 loan / 50,000 value = 0.80 LTV).

As the borrower continues making payments and as the loan balance gets lower, the LTV will get lower, because the loan amount is lower relative to the property's value (low LTV = less risk, high LTV = more risk).

The loan-to-value ratio can technically be whatever you're willing to accept, but an 80% loan-to-value ratio is a good starting point for the average deal. The LTV could go higher (the borrower puts down less money) if you feel the loan is low risk, or the LTV could be lower (the borrower puts down more money) if you feel the loan is higher risk.

There are some cases where taking additional collateral (also known as cross-collateralization) may make sense. For example, if the LTV is very high—say, 90, 100, or even 110%—this would normally be way too high. BUT, if you can take additional collateral from the borrower (whether it's another property they own, a piece of equipment, or cash from the borrower's bank account), this additional value could mitigate your risk.

Whatever collateral you want attached to your loan, you'll want to be sure this is spelled out clearly in your loan documents, giving you the authority to access these assets if the borrower defaults on their loan.

Borrower's Personal Guarantee

Speaking of collateral, another way for a seller/lender to secure their position and protect themselves is to have the borrower sign a personal guarantee. This is a very common requirement that banks ask for with commercial loans. I saw this requirement on every loan I closed in my commercial banking career.

With a personal guarantee, the borrower makes a written promise to pay back the loan. Without a personal guarantee, if the borrower can't pay back the money, the lender can't ask the borrower to pay it back from their own pocket. But with a personal guarantee, the borrower goes out of their way to say, “If my business can't pay, I promise I will pay with my own money.”

Personal guarantees can be written in many different ways, with different levels of specificity. Here are some of the different types of guarantees and the level of ‘severity' associated with each one.

1. Unconditional Guarantee: The person who signs this guarantee promises to repay the debt no matter what. There are no specific conditions that need to happen for this guarantee to be effective. If the debt isn't paid back, the guarantor must pay it with no “ifs” or “buts.”
2. Conditional Guarantee: In this case, the borrower's guarantee comes with certain conditions. The guarantor only has to pay if certain situations occur or conditions are met. If those conditions don't happen, the guarantor won't need to pay.
3. Unlimited Unsecured Guarantee: This type of guarantee means the guarantor is responsible for paying back all of the debt, and there is no limit to how much they could owe. “Unsecured” means no assets (like their primary residence, car, or savings accounts) are specifically pledged to back up the promise. If the debt isn't paid, the lender can seek repayment from the guarantor for the full amount, but they can't immediately seize assets because it's unsecured.
4. Unlimited Secured Guarantee: This is similar to the unlimited unsecured guarantee in that the guarantor is responsible for any amount of the debt. However, this is “secured,” meaning the guarantor has pledged assets like property as security. If the debt isn't paid, the lender can claim whichever assets are called out in the guarantee document.
5. Limited Unsecured Guarantee: Here, the guarantor's responsibility is capped at a certain amount, and no specific assets are pledged to back up the guarantee. Even if the debt exceeds the limit, the guarantor is only responsible for the agreed-upon amount and not a penny more. This often comes up when several minority owners own a business, and a 10% owner (for example) doesn't want to be liable for 100% of the outstanding debt.
6. Limited Secured Guarantee: In this arrangement, the guarantor is only responsible up to a certain limit, similar to the limited unsecured guarantee. However, this one is “secured,” meaning specific assets are pledged. If the borrower defaults and the debt is below or equal to the limit, the lender can seize those pledged assets, but only up to the agreed limit.

In my experience, personal guarantees aren't the “norm” with most seller-financed deals, but that doesn't mean you can't utilize them if needed.

For example, if you're extending a loan to a borrower for an amount that exceeds the value of the subject property (collateral) or if the property carries a higher-than-normal amount of risk and you want to be absolutely sure you get paid back by the borrower, you may want to consider having the borrower sign a personal guarantee to make sure you're covered.

Also, remember that a personal guarantee is only useful to the extent that the borrower has the financial strength to fulfill their personal guarantee. If they have absolutely nothing to their name, then they can promise the whole world but be unable to fulfill their promise. As such, if you go down this road, you'll also want to be sure you're doing your homework on the borrower.

• Get their past two years of tax returns to verify their income.
• Have them fill out a personal financial statement to verify they have the financial means to pay up if needed.
• If they pledge specific assets (like other real estate), get a schedule of real estate owned and verify they actually have ownership over the assets they're pledging.

Is it a hassle to jump through these additional hoops? Yeah, kinda.

But if the deal has enough risk to justify a personal guarantee, it will be worth the extra effort to make sure the additional risk is mitigated.

2. Seller's Right to Inspect Property

When you sell a property with owner financing, the property isn't truly out of your hands until that loan is paid in full. Regardless of the loan instrument you use, the subject property is a big part of what will protect you if the borrower decides to stop paying. As such, you need to ensure the property's value is maintained.

One thing that can seriously undermine and diminish a property's value is if the property is trashed, destroyed, or tarnished in some way.

This can be a huge issue with properties with buildings on them because buildings will fall apart by themselves over time if they aren't maintained (it takes some serious effort to keep buildings in good working order).

Even with vacant land, this can be an issue. For example, if a property is desirable because of its trees and the borrower decides to cut all the trees down, that can have a very material impact on the property's value and the lender's ability to re-sell it quickly (if they ever need to).

Vacant land can also be affected if the borrower leaves trash or broken-down vehicles on it or alters the property in some other way.

To ensure your borrower isn't destroying your property's value, it's important to include a clause that allows you to periodically inspect the property if necessary. When I deal with vacant land, this is pretty easy because any inspection can usually be done with a drive-by. Still, with houses or buildings, the lender will want the ability to get into the property if needed.

3. Maintenance, Alterations, and Adherence to Use Restrictions

Along the same vein of protecting the value of the subject property, it's important to specify what the borrower isn't allowed to do with your collateral.

This is a significant issue with vacant land because, if I don't specify what they can't do, the borrower could start taking down trees, defacing the property, and building a monstrosity that could seriously damage its resale value.

Because of this, I include a couple of clauses in my loan docs that say:

a. The borrower won't alter the property (removing timber, excavating the soil, installing or removing any septic or well systems, etc.) in any way without the lender's written consent.

b. The borrower will maintain and use the property following all applicable use restrictions.

This means the borrower can't do much to the property until they pay me off.

If this is a problem for the borrower, they can overcome it by paying off the loan, whether they cough up their own cash or refinance with a bank loan.

Once the property is in their name, I have my money, and my mortgage is wiped out, they can do whatever they want and deal with the consequences!

4. Borrower Pays Taxes and Insurance

Depending on the borrower, the property, and the annual cost of taxes and insurance, it's usually a good idea to make sure the borrower is covering these costs, and this should be spelled out in your loan documents.

In some cases (like with vacant land), property taxes could be nominal, and property insurance will be very inexpensive. In these cases, I could create an escrow account, add these annualized costs to the borrower's monthly loan payment, and then make sure these costs are paid myself. However you choose to handle it, it should be clear that this cost comes from the borrower's pocket, not the lender's.

5. Assignment and Assumption

Depending on your long-term strategy and plans with seller financing, there may come a day when you grow tired of collecting small monthly payments and want to cash out and move on.

If this day ever comes, you'll want to be sure you have the borrower's permission to do this.

It's fairly common for mortgage originators to sell their loans to other investors.

One crucial component you'll want to include in your loan docs is an assignment clause, giving you the unqualified right to assign your rights to a third party.

If you sell your note, you must give the borrower a written notice to inform them about the change. The note investor will wire you the agreed-upon price for the note; they will step into your shoes as the lender, collect the remainder of the payments, and take on whatever risk is associated with the deal. But it all starts with including the appropriate clause in your contract to ensure the borrower can't step in and stop the sale.

6. Deed in Lieu of Foreclosure

In real estate transactions, this provision allows the borrower to transfer the property title directly to the lender, avoiding the lengthy and costly foreclosure process.

If you have strong communication with the borrower, and they know they can't or won't continue making payments, a deed in lieu of foreclosure could be the most painless, seamless solution to resolve the issue. As long as they're willing to hand over the keys and forfeit their rights, this is the fastest and easiest way for both parties to move on.

7. Assignment of Rents or Leases

While this isn't common or necessary for most residential, non-income-generating properties, this could be something to consider if you're selling an income-producing property to a business.

This type of document is usually separate from the mortgage or note, and the purpose of this instrument is to enable the lender to collect income directly from whatever tenants are in the building if the borrower defaults.

When I worked in commercial banking, we always had our borrowers sign an Assignment of Rents and an Assignment of Leases.

Why?

Because we were lending to businesses that would be making money by leasing out part of the building (our collateral) to other tenants, so it made perfect sense.

8. Step-In Rights

This is another item that makes sense, specifically when you're selling a property to a business, especially when it's a business you know how to run.

For example, let's say you owned a self-storage facility or a car wash and sold the building and business to someone with seller financing. If that buyer/borrower quickly runs that business into the ground, this would give the lender (you) the right to step back into the driver's seat and take over the operation or management of the collateral property to protect its value and income-generating capability.

I've never used this one myself because I've never sold a business and a building together with seller financing, but if I ever did, I would want to be sure this provision was included.

9. Sale or Transfer Provisions

Also known as the due on sale or alienation clause, this can restrict the borrower from selling or transferring the collateralized property without the lender's consent. The goal of this clause is to ensure the lender maintains control over the key asset.

This clause is almost universally included in residential mortgages to ensure the lender can assess and approve any new owner's creditworthiness before the collateral (the property) changes hands. This is particularly important for the lender because it helps them maintain the value and security of the collateral.

10. Governing Law

In the unlikely event there is a dispute between you and your borrower, if you have to go to court to resolve the issue, you'll want to make sure you can handle all of this on your home turf without having to fly across the country to wherever the property or your borrower is.

You can set yourself up pretty easily with a clause like this:

Governing Law. This <<name of contract>> will be construed in accordance with and governed by the laws of the State of <<state name>>.

You'll want to insert the state you are located in so you don't have to travel far from home to deal with any issues that may arise.

Staying Protected

By incorporating these terms as the seller/lender, you can enhance your ability to manage risks, retain control over the collateral, and ensure multiple avenues for recourse in the event of a borrower's default. In fact, one of the biggest advantages of seller financing is that you can ultimately sell your property for a much better price. Here are seven reasons why you should try seller financing next time you're selling property.

It's also crucial to ensure that all provisions comply with applicable laws and regulations and are drafted clearly to avoid legal disputes.