As you navigate the world of real estate, the term owner financing will likely appear on your radar at some point. But you likely want to know what is owner financing and how does it work?
Luckily, you’ve come to the right place. We will take a closer look at the pros and cons of owner financing to help you decide if this is the smart play for you. With that, let’s dive right in!
What is owner financing?
When you encounter an owner financing opportunity, the seller is essentially offering to provide the property’s financing. With that, you would work directly with the seller to come to an agreement on loan terms. Owner financing eliminates the need for a bank to become a crucial intermediary in the sale.
As you become more familiar with owner financing, you may often hear it referred to as ‘seller financing’ or ‘creative financing.’ That’s because this is not the traditional way that a buyer would go about securing a loan for a property’s purchase.
Owner financing is often seen in buyer’s markets when the seller may have difficulty finding a buyer. However, the benefit of not needing to work with a bank for a loan can entice many buyers to consider an owner financing opportunity.
What does owner financing mean?
As a buyer in an owner financing situation, you would obtain your financing directly from the seller. Instead of filling out a mortgage application with a bank or other traditional lender, you will negotiate the terms of the sale and the loan terms directly with the seller.
Typically, the deal will involve less paperwork than a traditional sale in which you would need to secure a mortgage from a third party. But, of course, there is still quite a bit of paperwork involved with closing on a property with any kind of financing.
How does it work?
Often an owner’s financing deal is closed through a promissory note that outlines the terms of the agreement. The details outlined might include the consequences for default, interest payment considerations, and the loan term’s length. With so many details in play, it is common for an attorney to be involved in these deals.
It is worth noting that a traditional lender can slow down the process by requiring certain repairs to be done before you are able to move forward with closing on the house. With owner financing, you eliminate additional requirements set forth by a third-party lender. You will be able to move forward with the sale quickly if you are happy with the property as is which eliminates the need to put the deal on hold due to the restrictions of a traditional lender.
If an owner cannot finance the entirety of the deal, you could piece together the deal with additional loans from other lenders. For example, you could secure a traditional loan for a portion of the purchase price and owner financing for the difference. That could allow you to move forward with the deal even if the financing is tricky. However, bringing in additional lenders will likely slow down the closing process and potentially impose a need for more repairs on the property prior to closing.
How does owner financing work
When you are looking at properties, the seller will typically advertise if there is owner financing available. If you decide to make an offer on the property, you would negotiate the terms of the sale and the mortgage loan terms directly with the seller.
Throughout the process, you may have a realtor and an attorney involved. But you will not have a traditional lender involved to negotiate the terms of the loan separately. Once you and the seller come to an agreement on the loan terms and sale price, you can move forward relatively quickly.
After the terms have been decided, you’ll need to put the agreement into writing. Usually, this is done through the use of a promissory note with the help of an attorney. You should see the terms of the sale and loan outlined very clearly. There shouldn’t be any ambiguity in the wording of the sale agreement.
The advantages of owner financing
Owner financing is a unique opportunity to close a real estate transaction without the requirements of a third party lender. With that, there are clear advantages for both the buyer and the seller.
The advantages of owner financing for buyers
As a buyer, you stand to benefit greatly from owner financing. The biggest advantage is that this creative financing solution can allow for more wiggle room at the negotiation table. The seller wants to move the property and is willing to finance the sale, which puts more weight on any offer you make.
Additionally, the speed of the transaction will often be significantly faster. Instead of wading through paperwork from a traditional lender for weeks, you can move forward with the purchase more quickly.
A final benefit is that you could save thousands in closing costs. Most, if not all, traditional lenders have standard closing costs that can add up very quickly. You may be able to save yourself thousands of dollars by working directly with the seller.
The advantages of owner financing for sellers
Although most of the benefits fall to the buyer, sellers can still benefit from owner financing. As a seller, you’ll be able to sell the property as-is. Instead of dealing with a traditional lender that imposes requirements that could necessitate thousands of dollars of time-consuming repairs around your property, you can move forward without the added hassle.
Plus, when you finance the property’s purchase, you will create a regular income stream for the length of the loan term. That can be an enticing feature of owner financing as a seller.
The disadvantages of owner financing
As with all transactions, there are some disadvantages to both parties involved.
The disadvantages for buyers
As a buyer, you may encounter some downsides to owner financing.
First, the seller may require a larger down payment than a traditional lender. Although that is not true of all owner financing situations, it could be a factor in your deal. The purpose of a larger down payment is to help offset the risk for the seller.
A seller may also impose a higher interest rate than a traditional lender. That could cost you thousands over the lifetime of your loan.
A final caution for buyers considering owner financing is to be aware of the balloon payments. A balloon payment agreement is when you make small payments for a few years. But then you’ll need to pay the remainder of the loan at the end of a set number of years. Essentially, you’ll have a few years to find an alternative funding source. But that can be difficult depending on your situation. If you are unable to make the final lump sum payment, you may risk losing the property.
The disadvantages for sellers
The major disadvantage for sellers is that you run the risk of dealing with a foreclosure. With an owner financed home, a foreclosure would become your financial headache instead of a traditional lender’s.
If the new owner cannot keep up with the payments, you may need to exert time and money to reclaim the property. The best way to prevent this unfortunate scenario is to vet potential buyers before agreeing to sell the property to them with owner financing.
Additionally, you’ll have to deal with the upfront paperwork involved with selling a home.
Is owner financing a good idea?
Owner financing can be a good solution in some situations.
Although the seller of the property is put at more risk than the buyer of the property, both parties will need to do their due diligence before moving forward with the closing process.
As a seller, owner financing offers an opportunity to sell a property without any additional repairs. The responsibility of taking care of the property will be transferred when the new owner finalizes the loan.
As a buyer, owner financing presents an opportunity to buy without a traditional lender. Suppose you aren’t able to qualify for traditional financing offered by banks or other traditional lenders. In that case, a seller might be willing to work with you, depending on the market and your financial situation. But make sure to read the fine print of any deal before moving forward.
The bottom line
Owner financing, like all financing, has its pros and cons. But in some cases, the pros will dramatically outweigh the cons. Consider the benefits for your unique situation as you explore this financing possibility.