A Guide to Owner Financing A Home

The PropertyClub Team
May 9th 2020
Owner financing is when you get a loan from the seller of the home, and can be a good alternative to a mortgage for some buyers. This comprehensive guide will dig into how it works.

Since your home is probably the most expensive thing you’ll ever buy, the financing on it may also be your most profitable option when it comes to paying off a loan or getting more assets to make your family’s life better. Most people conduct their mortgages through a lender at their bank. However, owner financing is another less often used option that has its advantages and disadvantages.

This is a short guide to the benefits and drawbacks of owner financing and what you need to know to make the right decision for your needs.

What is owner financing?

Owner financing is the same as seller financing. It differs from a conventional bank financing plan conducted through a mortgage lender in that the seller doesn’t give the buyer any money. Instead, owner financing is conducted as a loan of credit on which the buyer makes regular payments until it’s paid off.

This loan covers the purchase of the property, though the buyer is still responsible for any down payments. This is handled through a financial document called a promissory note. To understand how seller financing works, you need to know what this is.

What is a promissory note?

A promissory note is a document through which an owner financing transaction is made. It is written documentation of the money to be paid to the seller, specified by them for a specific date, on a schedule.

When you finance, you are essentially going into debt willingly by being the recipient of a loan from a bank or, in this case, the seller. The promissory note is where all the terms of the loan are denoted, including the interest rate on the loan, the loan amount, and the parties’ signatures.

A promissory note is a financial tool through which the transaction will be made to get financing from a source other than a bank. You have to understand its limitations if you expect to make good on your loan. If you’re wondering how to owner finance your home, knowing the terms of your promissory note is one of the most crucial steps.

Typical owner financing terms are short-term – this may be the reason you wanted to avoid banks in the first place. Also, if an owner financing plan lasts more than five years, it stands to reason that the owner should be able to qualify for a traditional loan from a bank, or else they shouldn’t have financed in the first place.

Benefits of owner financing

Both buyers and sellers experience benefits from using owner financing as opposed to conventional bank mortgages. It’s important to know what they are so that you can sort your options and compare them to your needs.

Time

One of the worst aspects of traditional bank loans is the time it takes to process them. The bank’s legal department, loan officers, and underwriters must review, process, and approve your loan, which can be nerve-wracking if you need the money more quickly.

For faster loan resolutions, you may want to opt for owner financing.

Cost

For both buyers and sellers, there are cost benefits associated with owner financing.

The first obvious one is for buyers. Since you aren’t using a bank to conduct your loan transaction, you don’t have to pay third parties to appraise your property’s current market value or pay any bank fees to compensate them for their involvement. You are responsible for your legal terms and for conducting the transaction correctly, but you don’t have to shell out for compensation to your bank.

Sellers also benefit in terms of cost by using owner financing. Typical owner financing terms can be bargained down to a better rate more easily than with a bank loan.

Control

Those who don’t qualify for a bank loan can get the money they need by opting for a seller financing mortgage. The down payments are more flexible because there are no federal authorities involved, and the conditions of the deal are easier for you to control.

This also applies to sellers. After the loan has been made and the promissory note has been issued, you can sell the note to an investor to get the money in an immediate lump sum and not worry about collecting the payments.

Also, if your buyer bails on you, you still have the property, their down payment, and any payments they’ve already made. You’ve probably asked yourself, “is seller financing safe?” on more than one occasion. Though the payment procedure is only as reliable as your buyer, you’ll be happy to know that you’ll make money even if they bail on you.

A word of caution about Owner Financed Homes

There are some disadvantages to pursuing owner financing, however. Loans on owner financed homes tend to have higher interest rates than those negotiated by a bank, though, as mentioned, many of the upfront costs can be negotiated down.

Unlike a bank, seller financing can be difficult since the seller can deny you the loan without any reason. There is also the risk that the seller doesn’t fully own the house (such as in a case with an unpaid mortgage). In that case, the bank may call in their loan, which is now your loan, and you may not be able to pay it.
Seller financing is safe, but only if you make sure the title is clean beforehand.

The Takeaway

If you’re wondering how to owner finance a home, use this guide to sort out the particulars of the costs, benefits, documents, procedures, and potential drawbacks.

Typical owner financing terms can be controlled and agreed upon more freely than those of a conventional loan conducted through a bank. If you find yourself in a position as a buyer or seller that you’re considering using an owner financed home as a source of revenue or living space, be aware that the freedom comes with responsibilities.

Ensure that the owner has a clear title and that the terms are advantageous for you over a conventional loan. If they are, seller financing can be a great way to make good on your home’s value, or find a home at a below-average mortgage rate.