As more people step out of the realm of renting and jump into buying their first property, many have roadblocks keep them from getting a traditional mortgage to purchase their dream home. There is another option, though, and that's owner financing.
If you are unable to get a mortgage loan for one reason or another or are looking to still make money on your property after you sell it, then owner financing may be right for you. Here's what you need to know about it
What is owner financing?
When a buyer wants to make an offer on a house, they typically go to traditional lenders to get a bank loan to pay for the house. That's called a mortgage loan.
Sometimes people don't qualify for your traditional mortgage that is amortized over 30 years, however. When that happens, many people turn to owner financing. Owner financing is where the seller of the property you are looking to buy becomes your lender. The seller credits the house to you and in return, you make monthly payments to them.
Unlike traditional lenders, owner financing comes with deals such as a lower down payment, negotiable interest rates, and tailored monthly payments. Typically, the loan is set up with monthly payments and a high-interest rate for the first five to seven years. After the loan period is up, a lump sum payment (also called a balloon payment) comes due and the buyer can either pay it or refinance to cover the payments.
Owner financing does not have to be set up that way, though. It can be set up just like a traditional 30-year mortgage is set up where you make payments to the seller for the entire 30-year term. That's the beauty of owner financing—there is room for negotiating.
Types of Owner Financing
There are several different types of owner financing. The most common types are land contracts, mortgages, and lease-purchase agreements.
As the name denotes, land contracts are for land. In a land contract, the seller retains the deed to the property but the buyer gets what is known as an equitable title. The equitable title basically lets the general public know that the buyer is in the process of obtaining rightful ownership of the property.
As with traditional lenders, once you pay off the property in its entirety, you receive full ownership of the deed.
The seller still has a mortgage on the property (meaning they do not own it free and clear). Maybe the seller wants to avoid paying taxes or just is tired of managing the property and wants out of the mortgage. In any case, the buyer and seller negotiate a deal where the buyer has the title transfer to their name. They then pay the seller monthly mortgage and interest payments. The seller is then in charge of paying the mortgage lender every month from the income they receive from the buyer.
Also known as lease options, a lease-purchase agreement is where the buyer pays rent to the seller on the property for a set amount of years before they purchase the house with a balloon payment.
This type of financing may not be an option according to the Dodd-Frank Act put into place in 2016. The Dodd-Frank Act protects borrowers from getting into sticky situations where they won't be able to afford their house and buyer defaults on the loan.
As with some of the other types of financing, a promissory note outlines the terms of the contract that buyers and sellers agree upon when entering into a lease-purchase agreement. The seller holds onto the deed of the house until the buyer pays it off free and clear.
Benefits and Downsides to Owner Financing
There are many benefits to owner financing for the buyer and seller alike.
Benefits for the Seller
No matter how you structure the deal—whether the seller gets a large lump sum at the beginning of the transaction or makes a small profit from interest every month—the seller makes money. This is great for those baby boomers who are looking to offload their rental properties but not ready to give up that income. They get the best of both worlds by having someone care for the property while still receiving a monthly income.
When the buyer is working with a lender, the closing time typically lasts a minimum of 45 days. You can cut down the time between closing significantly by going with owner financing. That is because instead of dealing with a mortgage lender, the buyer and seller come to financing arrangements themselves and close much quicker.
Higher Interest Rates
Because you are the lender, you can (and should!) charge interest on the loan. That interest gives you an added monthly income and pays you back for the risk you are taking on as the lender.
Drawbacks for the Seller
If the buyer chooses to stop paying on the loan, the seller is then responsible for the payments plus whatever payments they are making on their current residence. This can be a lot to manage and a good contract can help prevent this from happening.
Along with the risk, if you have a wrap around mortgage and your mortgage as a due on sale clause, you could be in for a rude awakening. If the bank finds out, they can come and demand payments in full including any bank fees they tack on.
If the buyer backs out of the sale, you may have some repairs left. Those repairs will most likely need to happen before you can sell the property to another buyer.
Benefits for the Buyer
Lower Down payment
Because you aren't working with a traditional loan, you are able to negotiate a lower downpayment with the seller. The amount of the down payment depends on the purchase price of the property. It also depends on the seller's personal preference. Many buyers who use owner financing are able to negotiate a much lower interest rate than they would use with a traditional loan.
Traditional mortgages place restrictions on what type of property you can purchase. When you are using owner financing, however, you can pick a house that needs more repairs or a property that doesn't meet all of the standard mortgage requirements.
Faster Closing Time
As with the seller, a major benefit is that you are able to get in your property quicker than a sale that deals with a mortgage broker.
Drawbacks for the Buyer
Bigger Price Tag
Owner financing doesn't always come cheap. If you want the property you've had your eye on for a while, you may have to offer a few thousand more than the purchase price to get it.
Difficult to Find
Sellers that are willing to take on owner financing are few and far between. Many real estate agents know where to find them, however, so talk to a local expert agent in your area to help you find a property and seller that is okay doing owner financing.
How to Offer Owner Financing
There are multiple ways you can offer owner financing. In most cases, you should just be able to get your real estate professional to draw up a contract where you extend a line of credit to the buyer. From there, you'll receive payments to pay back the loan throughout the year.
If your bank loan is un-assumable and it is in the way of your owner financing, talk to your lender. You may be able to work out a deal to be able to offer it to the seller.
‧ ‧ ‧ ‧ ‧
Interested in buying or selling using owner financing? You'll need an experienced local real estate agent by your side. Clever partner agents are top rated and work for a great flat rate. Call us today at 1-833-2-CLEVER or fill out our online form to start.