While it’s true that a mortgage is the most popular way to finance a home, not everyone is in a position to meet its strict lending requirements. As such, you might want to consider owner financing instead. This is where the seller finances the purchase for you. Is owner financing right for you? That’s what we’re going to help you determine. Whether you are the buyer or the seller, knowing the pros and cons of owner financing will give you a better understanding of how it works.
Without question, buying a home is one of the biggest and most important investments you will ever make. As such, most homebuyers need to rely on some type of financing to make it possible, such as a mortgage. But what are you supposed to do when you’re unable to qualify for a mortgage? That’s where owner financing comes into play. As mentioned, owner financing is when the buyer finances the purchase of the home directly through the seller, thereby avoiding a bank or mortgage lender. When this financing option is agreed upon by both parties, the seller has the buyer sign a promissory note that details the loan. This includes the term, repayment schedule, and interest rate. There also needs to be an agreement as to what happens if the buyer defaults on their payments. In some cases, the owner will keep the house title until the loan is paid off in full. Although owner financing is an alternative to other loan options, some sellers may require a credit check beforehand. If your credit is less than stellar, you may not qualify. The good news is that you shouldn’t have to worry about the other strict requirements that mortgages are known for. As long as your credit is in good shape, you stand a good chance of the seller approving you. Owner financing is typically short-term, with most arrangements giving the buyer 30 years to pay off the loan. While this might not sound short-term, the idea is that within five to 10 years, the buyer will have equity in the home to qualify for a mortgage. This type of arrangement helps keep the monthly payments low while allowing the buyer to improve their finances. It’s important to note that you’ll want to speak with a trusted real estate attorney in any owner financing agreement. They can draw up the contract and promissory note while ensuring that nothing is overlooked. As ideal as owner financing may sound, it’s important to be aware of its risks, as well. Therefore, let’s explore the many pros and cons of owner financing so you can better decide if it’s the best option – both for the buyer and the seller.
There are several pros and cons that buyers need to think about before agreeing to any kind of arrangement.
Fast Closing One of the more appealing benefits is that you don’t have to wait to be approved by an underwriter, bank loan officer, or legal department. This ensures a much faster closing process compared to traditional loans. Flexible Down Payment Whereas other loan options require minimums from a bank or the government, owner financing does not. This makes it much easier for buyers to provide a down payment. Mortgage Alternative If you’re unable to secure financing via a mortgage, owner financing provides a viable alternative that’s far easier to get approval. Affordable Closing Since there aren’t any appraisal costs or bank fees, you can look forward to cheaper closing when you opt for owner financing.
Higher Interest Rates You’re likely to pay higher interest with owner financing compared to interest from a bank. Requires Seller Approval Although the seller might be OK with owner financing, there’s a chance that they won’t agree to be your lender. Due-on-Sale Clause One issue you might run into is the seller having a mortgage on their property. If this is the case, the lender or bank can demand that you pay the mortgage immediately. This is due to most mortgages having due-on-sale clauses . If the lender doesn’t get paid, you could face foreclosure. You can avoid this risk by making sure that the seller doesn’t have a mortgage and that they own the home free and clear. Alternatively, you can contact the seller’s lender for their agreement to owner financing. Balloon Payments Many owner financing agreements consist of a large balloon payment , usually due after five or 10 years. In the event that you are unable to secure financing at that time, you risk losing everything – your investment thus far, plus the house.
Just as there are pros and cons for buyers, the same applies to sellers, although the particulars are different. Let’s look at some ways sellers can benefit from owner financing, as well as why it might be best to avoid it.
Sell As-Is Sellers are able to sell their property without having to make costly repairs. This isn’t typical of traditional lenders, as they often require that the home be fixed up prior to selling. Sound Investment Sellers stand to get much better rates on the money they raised selling their home compared to if they invested the money elsewhere. Lump-Sum Payment As a seller, you have the option of selling the promissory note to an investor, resulting in you getting an immediate lump-sum payment. Keep the Title If the buyer cannot follow through on the agreement and defaults on their payments to you, you get to keep the down payment and any money paid. And since you’ll have the title, you get to keep your house, as well. Faster Sale Since there isn’t a traditional mortgage involved, buyers avoid the mortgage process, and you benefit from selling your home faster.
Dodd-Frank Act New rules apply under the Dodd-Frank Wall Street Reform and Consumer Protection Act that could exclude balloon payments as an option. As such, you may need to get a mortgage loan originator involved. This largely depends on how many properties you sell under owner financing each year. The Buyer Defaults If the buyer stops making payments and defaults on the agreement, you could be forced to go through an ugly foreclosure process if they refuse to leave. Additional Default Expenses In the event that you are forced to take your property back, you may be stuck with expensive repair costs if the buyer didn’t take care of the house. This is why it’s so important to carefully vet your buyer before agreeing to owner financing.
Real Estate Agents If you don’t qualify for a mortgage and are interested in owner financed homes, you have a few resources to help you find options, including: Both real estate agents and brokers near you might be aware of owner-financing homes in your area. If not, they could connect you with a seller who might be willing to sell to you under an owner financing agreement. Online Real Estate Listings There are a number of real estate aggregator websites that you can use to find applicable properties in your area. These sites typically allow the user to search for owner financing options only. Alternatively, you can simply perform a web search for “owner financed homes near me.” FSBO Listings Find FSBO (for sale by owner) listings near you. If you find a property you are interested in, you can contact the seller and ask them if they’d consider owner financing. Rental Listings As with FSBO listings, you might try landlords to see if they would be willing to sell to you under an owner financing agreement. You might find one who is ready to give up being a landlord and will consider your offer.
There are special circumstances in which owner financing can benefit both the seller and the buyer. In any event, it’s important to consider all possible risks before agreeing to any kind of arrangement. If you are interested in owner financing, working with a qualified real estate agent will be in your best interest. They can represent you throughout negotiations, handle the contract and promissory note, and ensure that you and your rights are protected. If you found this guide useful, we encourage you to explore our many other articles in our blog section . We cover a wide range of topics, from mortgage rates and home loans to starting a small business and improving your credit score. If you have any questions in the meantime, we invite you to reach out to our Seek Capital experts . We are happy to assist in any way that we can and look forward to serving you. Sources https://www.law.cornell.edu/uscode/text/12/1701j-3 https://www.consumerfinance.gov/ask-cfpb/what-is-a-balloon-payment-when-is-one-allowed-en-104/ https://www.congress.gov/bill/111th-congress/house-bill/4173/text