I personally have been the borrower on 2 owner financed notes on real estate that I own.
And I have helped several clients complete transactions with owner/seller financing.
I have learned a lot along the way. If you are considering an owner financed loan to buy real estate, this guide is for you.
We are going to look at both the benefits and the drawbacks.
What is Owner or Seller Financing?
Let’s take a quick look at what we are actually talking about.
Owner financing or seller financing mean the same thing. The seller of a property (in my case, residential real estate, but could be any real estate) agrees to finance the new buyer.
You, the buyer, agree to terms with the seller on the repayment of the loan.
You then will be responsible to make your payments directly to the seller of the property for an agreed upon amount, for an agreed upon timeframe.
In Virginia (my home state) a note and deed of trust are drafted before closing on the property and filed with the local courthouse.
So the financing from the seller becomes a lien on the home. You own the home, but the seller owns the lien.
If you do not pay or follow the other terms of the contracts, the seller can foreclose and take the home back.
Your state may be slightly different, so check with a local title attorney.
But the concept will be similar. You pay you stay, you don’t pay and the seller can foreclose and take the home back.
A lawyer will draft the loan documents, and you will pay the seller over time.
Here is an example of what the terms may look like.
|Down Payment||$50,000 (10%)|
|Amortized Over||15 Years|
|Balloon Payment||Yes ( in 5 years full balance due: $331,661)|
For this example, you are paying the seller $3,500 per month for five years, when the remaining loan balance is due.
This is just one of many scenarios. As you will see below, terms are negotiable.
The Pros of Using Owner Financing
This type of financing presents a unique opportunity.
1. Negotiable Terms
There is a large amount of flexibility with the terms of an owner financed loan.
When you get a conventional, FHA or VA loan, you can look at different loan options. But you won’t be able to propose different terms than what is offered.
With owner financing, you can negotiate the rate, the repayment period, how long the loan is amortized over, down payment, and more.
And you are only negotiating with the seller, so it is generally a quick and easy process.
2. The Seller Decides to Approve or Not
There are guidelines that banks and lenders follow for lending money.
If you fall outside of the guidelines, you won’t be able to get a loan.
With owner financing, you make your case to the seller on why you are financially solid for loan repayment.
There are no hard and fast rules that will eliminate you with owner financing. It is case by case.
But the seller will ultimately determine if you get the loan or not. Not underwriters bound by various regulations.
3. Less Paperwork Needed
The owner who is financing you will most likely do some due diligence on your finances and creditworthiness.
This could include a credit check, requesting bank statements, tax returns, employer verification, etc.
But the truth is, seller financing is usually an easier process than applying with a large bank or lender.
There is no underwriter, just the owner. So you won’t have to jump through as many hoops.
4. Lower Closing Costs
Down payment aside, the average closing costs are going to be lower with owner financing.
You won’t have lender fees and an appraisal is unlikely to be required (though you may want one anyway depending on the situation).
5. Option for Faster Closing
The approval process can be done fast, as most owners will make a quick decision on whether they want to move forward.
After that, you only will need to wait for the title attorney to draft the loan documents, and execute any other terms of the contract.
Other loans tend to need more time to close, depending on the bank this could be 30-45 days.
6. Potential for Adding More Properties
If you are a real estate investor, this is an important one.
After the financial crisis of 2007-2008, it became much more difficult to get multiple loans on investment properties at one time.
And that is not always a bad thing, as overleveraging yourself is never a good idea.
But, owner financing is one way to take advantage of a solid real estate investment opportunity if you are unable to get conventional loans.
The Cons of Using Owner Financing
And also some unique challenges.
1. Higher Average Interest Rates
1.-4. of the ‘cons’ list could be summed up like this: if you seek owner financing, there is often a reason why you do not go to a bank or lender. And the owner will want to cover for whatever risk is presented.
The primary way is by getting a higher than average interest rate.
Now this is not a guarantee, because the rate is fully negotiable.
But many owners will want a return that is higher than the conventional mortgage rate.
When calculating rates, I like to look at the Freddie Mac weekly mortgage survey to see what lenders are offering.
2. Usually Short Term Repayment Period
FHA, VA and conventional loans usually offer you 15, 20 and most commonly 30 year repayment periods.
Owners rarely will want to hold onto the note for that long.
You may be able to get a 30 year amortization, which is what your payments will be based on.
But often that does not mean that the repayment period will be 30 years.
On average owner financed loans are much shorter, and do this by including a balloon payment (see below).
3. Balloon Payments are Common
How do sellers get out of tying up their cash long term? Balloon payments.
If you see our example above, you will see that although the loan had a 15 year amortization for calculating payments, the remainder of the balance was due in the form of a balloon payment in 5 years.
That means you will owe the remaining principal balance once that 5 year mark hits.
This is crucial to keep in mind, because you will either have to refinance, sell the property or come up with the cash on this date.
Without proper planning, balloon payments can be a looming burden.
4. You May Pay More for the Property
OK, so maybe the owner gave you a good interest rate, low down payment and favorable repayment period.
Another negotiating point is the price of the property. Some sellers may want an above market price for taking on the note.
Is this a bad thing? Not necessarily. You have to look at the deal you are getting as a whole.
But it is something to keep in mind, as it is another point of negotiation.
5. Not All Owners Can Finance
Lots of seller financed deals are sold all over all the time. But it is still not extremely common.
Why? First of all, many buyers may obtain other financing, because that may make more sense and be a better deal.
But secondly, sellers may not be able to finance the home.
If they have a mortgage on the home themselves, it will most likely need to be paid off when the property is sold.
So if the seller owes $200,000 on their mortgage, they will have to come out of pocket to pay that off before they can provide you a note.
This is a burden many sellers cannot shoulder.
For practical purposes, assume that owner financing is possible on homes where the seller owns the home outright, or they are able to pay off existing liens when they sell.
6. Extra Steps for Credit Bureau Reporting
If you want to have credit for your mortgage payments, you will have to self report to the major bureaus.
Larger lenders will automatically report to credit bureaus so your credit score will be positively affected as you make payments.
This is not the case with seller financing. Which may or may not matter for you.
Is Owner Financing Right for You?
The real question you should ask is, “is this specific financing deal the best for me on this specific property?”
I like to take out an old school pen and paper, write out the terms, consider what I could get elsewhere (conventional financing, etc.) and then decide what is best for me and my family.
Buying a home, whether for investment or a primary residence, is a large financial transaction.
So it is good to think through all your options, and talk with a local real estate expert if you need more help.
Owner financing can be a great option. It can also not be the best option. It is case by case.
More Resources for Real Estate Investors & Buyers
Northern VA home buying guide. Has some good advice also for general home buying, though the rules will be related to Virginia real estate.
Owner financing, also known as seller financing, can be a useful alternative to traditional financing through a lender or bank.
This is especially true if you are an investor or cannot qualify for another loan for one reason or another.
If you are able to find a owner financed deal, the approval process can be easy and terms negotiable.
On average, seller financing has shorter repayment periods, higher rates or a higher sales price (sometimes all 3) than a loan through a bank or large lender.
It is a good idea to look at each purchase of real estate on a case by case basis, based on your finances and the terms of sale.