What is owner financing?
Owner financing is a transaction in which the seller of a property directly finances the purchase with the person or entity that purchases it, in whole or in part. This type of arrangement can be beneficial to both sellers and buyers because it eliminates the costs of a banking intermediary. Owner financing can, however, create much greater risks and responsibilities for the owner.
Key points to remember
- Owner financing is sometimes called “creative financing” or “seller financing”. It is generally disclosed in property advertising when owner financing is an option.
- Owner financing requires the seller to assume the risk of default of the buyer, but owners are often more willing to negotiate than traditional lenders.
- Owner financing can provide additional income to the seller in the form of interest and move a property faster to a buyer’s market.
Understanding homeowner financing
A buyer might be very interested in buying a property, but the seller will not budge from an asking price of $ 350,000. The buyer is willing to pay this amount and can save 20% less – $ 70,000 he earned from the sale of his old house. It is expected to finance $ 280,000, but it can only be approved for a traditional mortgage in the amount of $ 250,000.
The seller could agree to lend her the $ 30,000 to make up the difference, or she could agree to finance the entire $ 280,000. In either case, the buyer would pay the principal and interest on the loan to the seller monthly.
In many cases, owner financing lasts only a short time until the buyer is able to refinance to pay the owner in full.
Pros and Cons of Owner Financing
Homeowner financing is most common in a buyer’s market. A homeowner can usually find a buyer faster and speed up the transaction by offering financing, but this requires the seller to assume the buyer’s risk of default.
The seller may require a larger down payment than a mortgage lender to offset the risk. Down payments can range from 3% to 20% with traditional mortgage lenders, depending on the type of loan. Down payments can reach 20% or more in owner-funded transactions.
On the upside, these transactions may offer the seller monthly cash flows that offer a better return than fixed income investments.
Buyers usually have the greatest advantage in an owner-funded transaction. The general terms and conditions of financing are generally much more negotiable, and a buyer saves on the points evaluated by the bank and the closing costs when she makes payments directly to the seller.
Homeowner funding requirements
A homeowner financing arrangement should be facilitated by a promissory note. The promissory note will describe the terms of the arrangement, including, but not limited to, the interest rate, the repayment schedule and the consequences of default. The owner also usually retains title to the property until all payments have been made to protect against default.
Some DIY transactions can be managed entirely by the owner, but the assistance of a lawyer is generally advised to ensure that all the basics are covered. Paying for a title search can also be beneficial to establish that the owner / seller is, in fact, able to sell the property and can potentially release the title in exchange for funding some or all of the transaction.