Owner Financing in Real Estate
Buying a Home With Owner Financing
Asking a seller to give you owner financing to buy a home can be a tricky proposition. That's partly because if you ask the listing agent if the owner will carry some or all of the financing, the agent probably doesn't know. Why? The agent never asked. Probably doesn't care enough to ask, either.
If you ask the seller directly, the seller is likely to say no. Sellers often reject the suggestion of owner financing because nobody has explained the benefits or proposed owner financing as a way to sell the home.
However, for a seller whose home isn't selling or when traditional lender guidelines are tightened, owner financing suddenly becomes very popular. Owner financing is definitely a viable option for some in buyer's markets. Just not so much in seller's markets.
What Is Owner Financing?
When part or all of the purchase price, less the buyer's down payment, is carried by (financed by) the seller, the seller is providing owner financing. It doesn't matter if the property has an existing loan, except to the extent that the existing lender might accelerate the loan upon sale due to an alienation clause. Instead of going to the bank, the buyer gives a financing instrument to the seller as evidence of the loan and makes payments to the seller.
If the property is free-and-clear, meaning the seller has clear title without any loans, the seller might agree to carry all of the financing.
In that instance, the buyer and seller agree upon an interest rate, monthly payment amount and term of the loan, and the buyer pays the seller for the seller's equity on an installment basis.
The security instrument is generally recorded in the public records, which protects both parties. Bear in mind, some state laws prohibit balloon payments.
Some federal government legislation can also govern owner financing. You might want to obtain legal advice to make sure you are following the law.
Types of Owner Financing
Most purchase-money transactions are negotiable. Sellers and buyers are free to negotiate the terms of the owner financing, subject to usury laws and other state-specific regulations. Again, you might want to seek legal advice.
While there is no standard down payment required, many sellers want a sufficient down payment to protect their equity. Down payments can vary from very little to 30 percent down or more. Sellers feel their equity is safeguarded by the buyer's down payment because buyers are less likely to go into foreclosure if they've invested a lot of money upfront.
Some variations of owner financing include:
- Land Contracts.
Land contracts do not pass legal title to the buyer, but give the buyer equitable title. The buyer makes payments to the seller for a certain period. Upon final payment or a refinance, the buyer receives the deed.
- Promissory Notes and 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.
Selling on a lease purchase agreement means the seller is giving the buyer equitable title and leasing the property to the buyer. Upon fulfillment of the lease purchase agreement, the buyer receives 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 to Home Buyers
- Little or No Qualifying.
Even if the seller demands a credit report on the buyer, the seller's interpretation of buyer qualifications are 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 payment options such as interest only, fixed-rate amortization, less-than-interest or a balloon payment. Payments can mix and match. 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 to pay. 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 on a lender to process the financing, buyers can close faster and get buyer possession earlier over a conventional loan transaction.
Owner Financing Benefits to Home Sellers
- Higher Sales Price.
Because the seller is offering owner financing, the seller 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.
Owner financing can carry a higher rate of interest than a seller might receive in a money market account or other low-risk types of investments.
- Shorter Listing Term.
Owner financing attracts a different set of buyers. If a property is not selling under conventional methods, offering owner financing is one way to stand out from the sea of inventory and move a hard-to-sell property that otherwise might not sell.
In closing, before entering into a transaction with owner financing, please consult a real estate lawyer and obtain competent legal advice. Do not rely on your real estate agent for information, unless your agent is a practicing real estate lawyer.
At the time of writing, Elizabeth Weintraub, CalBRE #00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.