What Does Owner Financing Mean?
Owner financing means that the seller, aka the current owner, of the home will give the buyer a loan to purchase it. Owner financing is an alternative to a traditional mortgage loan and can allow a buyer to purchase a home without having to get a traditional mortgage.
Typical Owner Financing Terms
Most owner financing deals will differ from traditional mortgages as their terms can be quite different. To start, most owner financing loans need to be repaid within 10 years. Interest rates are also typically higher for owner financing transactions. Down payment requirements can vary but are usually up to 10%.
While this may seem stricter than a traditional mortgages, there are some advantageous terms when owner financing. Buyers with low credit or low incomes often have an easier time getting owner financing. Additionally, owner financed deals typically close faster and have lower fees than traditional mortgages.
How to Owner Finance a House
- Use a Promissory Note
- Sign a Contract For Deed
- Use a Rent-to-Own Agreement
- Consult an Attorney
1. Use a Promissory Note
You can use a promissory note for an owner financing transaction. The promissory note will document the terms of the contract including the money to be paid to the seller, specified by them for a specific date, on a schedule.
When using a promissory note for seller financing, the buyer is going into debt willingly by being the recipient of a loan from 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. Typically, the deed will be transferred to the buyer and the promissory note will be secured by the house.
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.
2. Sign a Contract For Deed
Another option available for seller financing is a contract for deed. A contract for deed will give the buyer possession of the home immediately, but the deed and title will only be transferred once they make full payment to the seller. Essentially, the seller remains the owner of the house until the buyer completes his contractual obligations and pays the seller in full.
3. Use a Rent-to-Own Agreement
Another option to owner finance a house is to use a rent-to-own agreement, also known as a lease option. With a rent-to-own agreement, the buyer will pay the seller rent for a set period of time in return for the option to purchase the home. If the buyer purchases the house, most of the monthly rent will be applied toward the purchase price.
The buyer can also choose to abandon the lease option. For this reason, the monthly rent in a rent-to-own agreement tends to be higher than the market rate.
4. Consult an Attorney
Owner financing a house is complicated, so the first thing you should do is consult with an experienced attorney. They will offer advice on how to structure the sale, and can also draft the necessary agreements when you're ready to move forward with the deal.
Depending on how complex the deal is and what type of owner financing agreements you use, an experienced real estate attorney will charge anywhere from $1,000 to $5,000.
How Does Owner Financing Work?
Owner financing works as a loan of credit offered by the seller to the buyer, 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.
Overall, seller financing differs from a conventional bank financing plan conducted through a mortgage lender in that the seller doesn’t give the buyer any money.
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, seller financing is another less often used option that has its advantages and disadvantages.
Is Owner Financing Safe?
Owner financing is safe as long as the seller and buyer understand their obligations and the terms of the deal. However, there are more risks associated with seller financing than with a traditional bank loan. To ensure the transaction goes as smoothly as possible, it's always recommended to have an attorney help draft the owner financing agreement.
Owner Financing Pros
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.
1. 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.
2. 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.
3. 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.
Owner Financing Cons
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.
Owner Financing Bottom Line
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.