Owner financing is a type of creative financing in which the property owner acts as the lender and provides funds to the home buyer. These mortgages are financed by the owners, and they work similarly to other mortgages, except that the lender is the homeowner instead of a bank.
For a real estate agent, it is essential to understand the concept of owner financing. Most of your clients won’t even know they can qualify for owner-financing if they don’t qualify for other mortgages. As a real estate professional, you must know how to guide your clients better so they are fully aware of the financing options available.
In this post, I’ll define owner financing in detail and explain how it can be useful for home buyers. Read on to understand owner financing and its types.
What Is Owner Financing?
Owner financing is a process in which the property owner provides funds to the buyer to purchase the property. This financing is helpful if the borrower can’t qualify for a traditional mortgage because of strict eligibility requirements. The financing can be partial or complete depending on the borrower’s requirement. The buyer, instead of applying for a loan from a bank or credit union, gets the funds from the homeowner and repays the amount in monthly payments according to the pre-agreed terms and conditions. This is a good option for those buyers that don’t qualify for a conventional mortgage.
This is a financing process that takes place between the owner and buyer of the home. The owner is responsible for providing funds to the buyer to purchase the home. The owner and seller of the property are not always the same. However, in most cases, the seller is the property owner. For this reason, owner financing is also called seller financing.
In owner-financed arrangements, instead of the bank, the owner sets the interest rate and other details of the financial agreement, and the borrower has to pay back the amount, including interest and principal, to the owner. In the case of owner financing, the mortgages might mature a few years earlier than a conventional mortgage with a large balance due. The home buyer mostly has to pay a lump sum in the form of balloon payment to repay the remaining amount to the owner.
How Does Owner Financing Work?
In owner financing, the homeowner or seller arranges a part or all of the funds that the buyer needs to purchase a property. This type of financing works for properties in which the seller owns the property free and clear. The borrower can benefit from the owner finance option if they don’t want to go through the complex and lengthy procedure of applying for a mortgage at a bank or credit union. The borrower should consider their interest rates, term, and closing costs to determine whether the owner-financed deal is affordable for them or not. The owner will evaluate the borrower’s details, and if both the owner and the buyer come to a point, an agreement takes place. When the borrower gets the funds as a lump sum, they can pay the amount in monthly payments to the owner, which include the interest and the principal.
Steps to Obtain Owner Financing
Homebuyers can get several benefits with owner financing. The owner provides financing to the home buyer so they can easily purchase the home. This type of financing is for the buyer’s convenience, who can’t qualify for other conventional mortgages due to their strict eligibility requirements. The borrower might not qualify for a conventional mortgage because of their credit score or employment status, but an owner-financed arrangement doesn’t have strict requirements. However, since the borrower doesn’t have a perfect credit score or other eligibility requirements, the property owner offers these funds at a higher interest rate.
Additionally, owner financing doesn’t help improve credit scores because the owner doesn’t report the rating to the major credit bureaus. Still, owner financing is a good option as it outweighs the strict process of qualifying for a mortgage. Most owner-financed transactions are short-term ones and involve balloon payments. This means that the borrower has to repay the amount in a lump sum amount within three to five years. The following are the steps to obtain owner-financing:
Search for Owner-Financed Homes
If the borrower can’t qualify for a mortgage, they can look for owner-financed homes. The borrower can go through real-estate websites and search for “owner-financed homes near me” to get the best option. Besides that, real estate agents and brokers in the borrower’s area can also help them get a good deal for owner-financed homes. The borrower can also look for FSBO (Find for Sale By Owner) listings or go through the rental listings to get an owner–financed home.
Prep your Credit Score
Before applying for owner financing, the borrower must also prepare their credit. They can determine their credit score from the three major credit bureaus; their service is also available online. A good credit score will improve the chances of getting a good financing option for the borrower. Though sellers and owners don’t follow a stringent credit check process as traditional lenders do, having a good credit score can improve the chances of getting better terms. However, owner-financing can’t be used for debt consolidation as the owner or seller doesn’t report the timely payments of the borrower to the credit bureaus.
Owner-Financing Contract
An owner-financing contract or agreement takes place in the form of a promissory note or deed of trust. The document must include important details of the owner-financed transactions. For example, it must list the purchase price, amount, down payment, and interest rate. The promissory note should also include the term and the amortization schedule. Since most owner-financed transactions include balloon payment, the note must include details for the balloon payment too. There must be details regarding penalties in case of late payments and default.
Check the Deed
Before applying for owner financing, the borrower must first check the deed. A deed is a document that shows the ownership of the buyer of the property. When the buyer signs a promissory note and makes an agreement on the home’s purchase price, chances are that the owner offers a deed to the borrower after payments on the deal are complete.
Apply for Owner Financing
Once the borrower has prepared all the necessary documents and selected an owner-financed home, they can apply for owner financing. Obtaining the lowest cost owner financing is the best option, but the borrower must double-check the closing costs they’ll have to pay. The borrower signs a promissory note, after which they can start making the monthly payments to the owner or seller.
Owner Financing Example
Example: David wants to purchase a property worth $300,000, and the owner isn’t ready for a bargain. David decides to pay a 20% down payment, that is, $60,000, to the owner and has to pay $240,000 remaining to purchase the property. On the other hand, David had also applied for a mortgage, but he could qualify for a $100,000 mortgage based on his credit history and financial performance. David still has to pay $140,000 more to the owner. In this situation, the owner offered funds to help David purchase the property. This is an owner-financing method in which the amount is $140,000.
David now has two different mortgages for which he has to make monthly payments. One is the one he took from a bank which is $100,000, and the other is the owner-financed fund of $140,000, which he took from the owner. The owner has, however, offered the funds for only five years for David to pay back the amount. The following is a breakdown of the owner-financed arrangement:
- Funds: $140,000
- Term: 5 years
- Interest rate: 6%
- Monthly payment: $2,018.89
- Balloon payment: $50,000
After five years, when the loan matures, David has to pay $50,000 as a lump sum to the owner who financed the deal. This was an example of partial owner-financing. In some cases, the owner offers an amount to finance the entire home purchase.
Frequently Asked Questions
What are the Benefits of Owner-Financing?
Some of the benefits of owner-financing include removing third-party interference in the financing process. This saves a lot of time and cost for the participants. Owner financing is already useful when a conventional mortgage is hard to get; in such cases, the borrower can purchase the property and repay the owner in monthly payments. For sellers, this is beneficial too, as they can sell their property to the potential borrower and collect monthly payments and a balloon payment in the end. Owner-financed transactions offer faster and cheaper closing and are a good option for home buyers who can’t secure a mortgage.
What are Some Issues that the Borrower Might Face with Owner-Financing?
There are a few potential issues that borrowers might face with owner financing. For instance, if the owner-financed deal was recorded incorrectly, the home buyer will face various issues as no third party is involved. Thus, it is important to finalize the agreement with the owner and make sure that the deed is transferred and filed with the county government. On the other hand, with owner financing, the borrower can’t improve their credit score or use the funds for the consolidation of debt. This is because the owner doesn’t report the payments to the credit bureau. Besides that, owner-financed deals have higher interest rates because of the risk involved. These financing methods also involve a balloon payment which is a lump sum amount that the borrower has to pay to the owner. The balloon payment can be difficult for some to repay to the owner.
Who Holds the Deed in the Owner-Financed Transactions?
In most cases, the owner holds the deed until the home buyer pays the amount in full. The owner transfers the deed to the home buyer after the buyer makes the full payment. However, it depends on how the agreement is structured and what state the transaction occurs in.
What to Know for the Real Estate Exam
Owner financing is a good option for borrowers who want to avoid strict eligibility requirements and lengthy application procedures. An owner-financed transaction is often the best solution when the borrower can’t qualify for a conventional mortgage. However, owner-financed transactions might offer higher rates than conventional mortgages because of the risk involved.
In real estate, owner financing is used to purchase any type of property, and it involves legal paperwork. One of the biggest issues with owner-financing is that if the property owner has an existing mortgage on the property, the mortgage is no longer assumable. If there is an existing mortgage, the borrower can’t get the full title until the mortgage is paid in full. Owner financing is more beneficial for buying purposes as compared to selling.
If you want to learn more about other such terms, go through these Real Estate Definitions.
