A Guide to Owner Financing
The Ins and Outs of Buying a Home With the Seller's Help
Asking a seller to help you buy his home sounds crazy, no? It's certainly not something most homeowners, or even their listing agents, usually consider. However, for a seller whose home isn't selling or for a buyer having trouble with traditional lender guidelines, owner financing is definitely a viable option. Also known as seller financing, it's especially popular if the local real estate scene is a buyer's market.
What Is Owner Financing?
Owner or seller financing simply means that the current homeowner puts up part or all of the money required to buy a property. In other words, instead of taking out a mortgage with a commercial lender, the buyer is borrowing the money from the seller. Buyers can completely finance a purchase in this way, or combine a loan from the seller with one from a bank.
For the financed portion, the buyer and seller agree upon an interest rate, monthly payment amount and schedule, and other details of the loan, and the buyer gives the seller a promissory note agreeing to these terms. The promissory note is generally entered in the public records, thus protecting both parties.
It doesn't matter if the property has an existing mortgage on it, although the homeowner's lender might accelerate the loan upon sale due to an alienation clause. Generally, the seller retains title to the home until the buyer has repaid the loan in full.
Types of Owner Financing
Sellers and buyers are free to negotiate the terms of owner financing, subject to state-specific usury laws and other local regulations; some state laws, for example, prohibit balloon payments.
While not required, many sellers do expect the buyer to provide some sort of down payment on the property. Their rationale is similar to any mortgage lender's: They assume that buyers who have some equity in a home are less likely to default on the payments and let it go into foreclosure.
Owner financing can take several forms. Some variations include:
- Land contracts. Land contracts do not pass full legal title of the property to the buyer but give her equitable title. The buyer makes payments to the seller for a certain period. Upon final payment or a refinance, the buyer receives the deed.
- Mortgages. Sellers can carry the mortgage for the entire balance of the purchase price (less the down payment), which may include an underlying loan. This type of financing is called an all-inclusive mortgage or all-inclusive trust deed (AITD). The seller receives an override of interest on the underlying loan. A seller may also carry a junior mortgage, in which case the buyer would take title subject to the existing loan or obtain a new first mortgage. The buyer receives a deed and gives the seller a second mortgage for the balance of the purchase price, less the down payment and first mortgage amount.
- Lease-purchase agreements. A lease-purchase agreement means the seller is leasing the property to the buyer, giving him an equitable title to it. Upon fulfillment of the lease-purchase agreement, the buyer receives the full title and typically obtains a loan to pay the seller, after receiving credit for all or part of the rental payments toward the purchase price.
Owner-Financing Benefits for Buyers
Buyers who opt for seller financing can enjoy several advantages.
- Little or no qualifying. The seller's interpretation of buyer qualifications is typically less stringent and more flexible than those imposed by conventional lenders.
- Tailored financing. Unlike conventional loans, sellers and buyers can choose from a variety of loan repayment options, such as interest-only, fixed-rate amortization, less-than-interest, or a balloon payment (if the state allows it), or even a combination of these. Interest rates can adjust periodically or remain at one rate for the term of the loan.
- Down payment flexibility. Down payments are negotiable. If a seller wants a larger down payment than the buyer possesses, sometimes sellers will let a buyer make periodic lump-sum payments toward a down payment.
- Lower closing costs. Without an institutional lender, there are no loan or discount points, and no origination fees, processing fees, administration fees, or any of the other assorted miscellaneous fees that lenders routinely charge, which automatically saves money on buyer closing costs.
- Faster possession. Because buyers and sellers aren't waiting for a lender to process the financing, buyers can close faster and get possession of the property sooner than with a conventional loan transaction.
Owner-Financing Benefits for Sellers
A variety of advantages for sellers arise in owner-financing situations as well:
- Higher sales price. Because the seller is offering the financing, he may be in a position to command full list price or higher.
- Tax breaks. The seller might pay less in taxes on an installment sale, reporting only the income received in each calendar year.
- Monthly income. Payments from a buyer increase the seller's monthly cash flow, resulting in spendable income.
- Higher interest rate. The owner-financed loan can carry a higher rate of interest than a seller might receive in a money market account or other low-risk types of investments.
- Quicker sale. Offering owner financing is one way to stand out from the sea of inventory, attracting a different set of buyers and moving an otherwise hard-to-sell property.
Advantageous as it can be, owner financing is a complex process. Neither buyer nor seller should rely just on their respective real estate agents but instead should engage real estate lawyers to help them negotiate the transaction, ensuring that their agreement conforms to all state laws, covers every contingency, and protects both parties equally.