If you’re on the market searching for your dream home but are struggling with loan preapproval, owner financing is an alternative that can keep your homeownership within reach.
The practice of owner financing goes by many different names, including seller financing and purchase-money mortgages. But they all mean the same thing and refer to a real estate lending transaction in which a property owner is also a mortgage lender. This type of transaction eliminates the need for a conventional financial institution to take care of the financing agreements and negotiations.
Owner financing makes the entire process less complicated by eliminating some stages of a traditional loan, such as the home appraisal and inspection.
It also helps buyers that don’t qualify otherwise for a traditional mortgage.
Owner financing can be advantageous for sellers and buyers because it eliminates the costs of a bank intermediary. But let’s see what owner financing is, the types of owner financing, the benefits, and whether any risks come with it.
What is owner financing?
Owner financing is an alternative way for buyers to fund the purchase of a property that doesn’t include a traditional lender or involvement with a bank or financial institution. Instead, the homeowner will finance the purchase themselves. The buyer will then be supposed to repay the seller by making monthly payments based on the terms, time frames, and interest rates agreed by both parties.
In most owner-financing arrangements, the seller records a mortgage against the property sold through deed transfer to the buyer. In land contract arrangements, the seller might retain the title instead as leverage.
In the owner financing agreement, the property buyer must make a down payment ranging from 10 to 20 percent of the purchase price.
Owner financing is usually not reported on the buyer’s credit report. A substantial down payment is typically required, which makes up for the fact that the funding isn’t dependent on the buyer’s income or credit history. Although, sellers should perform a credit check regardless.
Owner financing is usually more expensive than traditional financing from a lending institution. However, some perks come with using this type of agreement.
It also is a viable option for homebuyers that find it hard to qualify for a mortgage from a conventional lender. Let’s take a look at the several types of owner financing available and their particularities.
Types of owner financing
1. Promissory note or mortgage
This type of financing is basically the same as a traditional mortgage deed, in which the buyer signs a contract declaring that the lender holds security on their property until the loan is paid off. In this scenario, the buyer receives the property’s title, and the local government records the mortgage.
2. Deed of trust
A trust deed, also known as a deed of trust, is a document often used in real estate transactions.
The deed of trust consists of an agreement between the borrower and a lender to have the property held in trust by a neutral and independent third party until the loan is paid off.
3. Contract for deed
In this agreement, the homebuyer does not receive the deed and the property’s title until the loan amount is paid entirely. Until then, the seller keeps the act and the property’s title.
4. Lease-purchase agreement
In a lease-purchase agreement, also known as a rent-to-own agreement, the buyer leases the property for a certain period before deciding on the final terms of buying the home. If the buyer chooses to purchase the property at the end of the lease period, the rent paid during the lease goes toward the purchase price.
The benefits of owner financing
- Time-effectiveness – one of the worst parts of traditional loans is the time it takes to process them. For faster financial solutions, consider owner financing. The institution’s legal department, loan officers, and underwriters must analyze, process, and approve your loan, which can be time-consuming.
- Costs– Since there isn’t a third party involved in the financing process, such as a conventional financial institution, you don’t need to pay for the appraisal of the property or any bank fees as it would be in case of their involvement.
- Flexible agreement terms– Sellers and buyers can make their terms and conditions of the agreement upon both agreeing without involving a financial institution. Of course, they still have to follow the local governmental regulation, and it is recommended to have a real estate attorney oversee the process. However, owner financing is more flexible compared to a traditional institution.
- Easier to qualify – There’s little to no qualifying involved. The seller’s interpretation of the buyer’s qualifications is typically less rigorous and more flexible than those imposed by conventional lenders.
Risks of owner financing
- Balloon payment– Sellers usually don’t give their buyers 15 or 30 years to repay their loans. The timeframes are shorter, and a seller can require a buyer to make a large lump payment at the end of the loan period and then apply for a traditional home loan. If you cannot afford the balloon payment, owner financing might not be the right choice.
- Higher interest rates– Homebuyers might pay less upfront, but over time, they could end up overpaying. It is a result of the potential higher interest rate. Like traditional financing, a seller might conduct a rigorous check of the buyer’s credit history and income before lending the money. As a consequence, a low credit score could determine the seller to request a higher interest rate.
- Consequences of Default– Despite the advantages of owner financing, it can be risky for sellers. For example, if the buyer defaults on the loan, the seller might face foreclosure. Mortgages often come with clauses that require payment by a specific time; missing that date could be a disaster. Even though you might end up possessing the property, you may need to make significant repairs before putting it back on the market.
Owner financing presents benefits and risks for buyers and sellers alike. With these agreements, buyers with lower credit scores or incomes may be able to obtain loans that they could not be approved for otherwise.
But at the same time, the interest rate a seller may charge may exceed the one required by a traditional lender. Thus, while owner financing can create more opportunities for aspiring homebuyers regarding real estate transactions, utilizing them doesn’t always make sense.
To ensure you remain on the safe side and learn more about owner financing, research and consult with a qualified professional such as a real estate attorney, before entering this type of arrangement.
Review the terms and conditions of any owner financing contract, too – they may vary significantly between agreements. Analyze carefully to see if upfront savings on a property purchase made in this fashion may cost you more in the end.
Whether it’s a safe choice depends on how clearly the agreements are drawn. That’s why it is crucial to have a real estate attorney oversee the entire process.
If this type of arrangement is viable for you, let us know in the comments below. We will be more than happy to find out your opinion on the subject.