When people buy a home, they are most likely to finance it with a mortgage. However, lending guidelines can be incredibly strict, and some buyers won’t be able to qualify.
This leads certain prospective home buyers to look for an alternative means of buying property. One of these alternatives is owner financing. Essentially, this is an agreement between the seller and the buyer of the property in which the seller finances the purchase.
Defining Owner Financing
The home buying process is a complicated one, and it can be especially stressful for someone who is a first-time home buyer.
A home is a large purchase. Accordingly, financing the purchase of real estate is a matter of necessity. When a buyer cannot get approval for a mortgage, they may try to arrange for owner financing. This involves the purchase being financed directly through the home’s seller. The result is that a bank or mortgage lender is not involved in the transaction.
How Does It Work?
Owner financing works differently than a conventional mortgage. The buyer doesn’t receive funds to buy a home from the seller. Instead, the seller must extend credit to the home buyer to cover the purchase price. The buyer typically is required to make a down payment. The balance of the extended credit is paid off by the buyer in regular payments.
At the time the seller and the buyer enter into the agreement, the buyer is asked to sign a promissory note to the seller. The promissory note contains all of the particulars pertaining to the agreement. These particulars, which are called terms, may include items such as the interest rate, the schedule of payments and what the consequences will be if the buyer defaults.
It is fairly common for the current owner, or seller, to retain the title to the house until the buyer has paid off their obligation.
While mortgages frequently extend for 15 or 30 years, owner financing agreements tend to be shorter in duration. As an example, the repayment schedule may be amortized over a typical 30-year period so that the monthly payments stay low and accessible. After about five or ten years, a balloon payment is due. The concept behind this schedule is that after that five or ten year period, the buyer will either have acquired enough equity or improved their financial circumstances enough to qualify for a traditional mortgage.
Owner financing can be a great arrangement for both parties, but it also carries risks for each. It is always wise for the buyer and the seller to meet with experienced real estate lawyers who can represent them and help to create an agreement that is fair, legal and equitable.
Pros and Cons for Buyers
While owner financing can be a fantastic solution for home buyers it is not without risks. Here is a closer look at pros and cons for the buyer.
Pros for Buyers:
- The closing process is faster: Because there is no involvement from a legal department, an underwriter and a loan officer, the closing process tends to be streamlined.
- Closing is less expensive: Without appraisal costs and bank fees, the buyer gets to keep some money in their pocket.
- Options for down payments: Owner financing does not come with required minimum down payments like mortgages frequently do.
- Available to those who cannot qualify for traditional financing: When a buyer cannot secure a mortgage, owner financing still can put home ownership within reach.
Cons for Buyers:
- Increased interest rate: Typically, the interest rate for an owner financing arrangement is higher than that charged on a traditional mortgage.
- The seller’s willingness is imperative: There can be no owner financing if the seller is not on board. Some sellers simply are not willing to take the risk.
- Balloon payments: It’s common in owner financing agreements for a large payment to be due approximately five or ten years after the agreement is finalized. If the buyer cannot secure a mortgage by the time the balloon payment is due, they may lose all of the payments they have made and the house.
- Due on sale clause: It is relatively common for a mortgage to have a due on sale clause that requires the seller to pay back their debt as soon as the house is sold. Accordingly, if the current owner has a mortgage on the property, they may not be in a position to offer owner financing.
Pros and Cons for Sellers
Home sellers are equal partners in the owner financing agreement. Accordingly, they may be subject to certain risks and benefits.
Pros for Sellers
- A promising investment: It is possible for the owner to earn a better return on money raised from selling their home than they would if they invested the money elsewhere.
- Lump sum opportunity: The owner may be able to sell the promissory note to an investor, which provides the owner with an immediate lump sum payment.
- Selling the home “as is”: Banks and mortgage companies frequently require certain repairs to a property before it can be financed. This requirement is not included in an owner financing agreement.
- Keep the title: Should the buyer default, the owner can retain the down payment, any payments that were made and the home itself.
- Making a quicker sale: This can be a great option if the seller needs to make a fast sale.
Cons for Sellers:
- The Dodd-Frank Act: This federal law placed new rules on owner financing that may affect the ability to require balloon payments. Moreover, some of these transactions must now involve a loan originator. It is advisable to consult with a real estate attorney before striking a deal.
- Cost of repairs: If the owner ever has to take back the property, then they are responsible for paying for any maintenance and repairs that may be needed.
- Default by the buyer: It is a possibility that the buyer will stop making payments. If they do and they don’t vacate the premises, you may have to begin the foreclosure process.
Let the Waypointe Group Help You Explore the Possibilities
If you are interested in exploring the possibilities of home ownership, which may include owner financing, get in touch with the Waypointe Group. Our expert Realtors can help you find the right circumstances that may ensure that you achieve your dream of home ownership.