Buying a home can be a stressful experience, especially when you are trying to come up with the funds to purchase it. Fortunately, there are many different options for financing.
You may have heard of mortgages, or third-party financing, where a bank or other lending institution provides a loan to the buyer that the buyer pays back over time. But when a buyer cannot get financing through a lender (or just decides not to), sometimes the seller will provide financing to the buyer.
This is called owner financing or seller financing and similar to a mortgage, the buyer pays the seller a pre-determined amount of money in regular intervals until the loan amount is payed off.
This post explores owner financing, which situations it’s most commonly used in, and the pros and cons for both the buyer and seller.
When Would You Use Owner Financing?
Although there are many reasons why both a buyer and seller might agree to owner financing, two of the most common circumstances where owner financing work in a home purchase are:
- The buyer is having problems qualifying for a bank loan. If the buyer has poor credit, too little credit history, or otherwise has issues getting a standard mortgage, owner financing offers the buyer another option for purchasing the home. They might even have an easier time negotiating the home price, interest rate, or other details with the homeowner rather than a bank, lender, or real estate agent.
- The home seller is having trouble finding a buyer. If the home has been on the market for a long time and the seller decides to offer owner financing, they immediately have access to a whole new group of potential buyers that may have otherwise been discouraged from looking at the property.
How Does Owner Financing Work?
Owner financing works exactly how it sounds – the homeowner provides financing in the form of a loan to the person who buys their property.
The basic process usually starts with the buyer and seller agreeing to the details of the sale by signing a Real Estate Purchase Agreement.
Once that is done, a Promissory Note is used to outline the details of the loan (including an interest rate and repayment schedule) and enforces the buyer’s promise to pay back the loan within the amount of time indicated in the note.
Combining a Real Estate Purchase Agreement and Promissory Note is a common way to provide owner financing in a real estate transaction.
LawDepot’s Contract for Deed can also be used for owner financing, but the seller needs to completely own the property (meaning the property is entirely paid off). Using a Contract for Deed may be simpler, as a Promissory Note is not needed if this document is used, but it may pose greater risk for the seller.
Whichever option you choose, it’s important to do research to determine which financing method works best for your situation.
What Are the Pros and Cons of Owner Financing for Buyers?
As you can probably imagine, owner financing in a real estate purchase has different advantages and disadvantages for both buyers and sellers.
For buyers, seller financing has the following advantages:
- Closing a home sale can be quicker with seller financing. Since the loan doesn’t have to go through a number of financial and legal departments that typically would be associated with a lending institution or bank, the buyer can take possession of their new home faster.
- The overall costs associated with selling the home can be lower. Without having to pay things like bank fees or appraisal costs, the cost to the buyer is lower than it would be if they went through a third-party. Also, the down payment amount required for the home tends to be more flexible.
- Buyers have a financing option if the bank turns them down. If a buyer is unable to get a loan through a third-party like a bank, owner financing provides them with an alternative financing option.
For buyers, seller financing also has the following disadvantages:
- The buyer can end up paying a higher interest rate than they would to a bank. Since the seller determines the interest rate, it is possible that they would want to ensure the highest possible return by charging the buyer a high interest rate.
- The buyer still needs to provide proof that they will pay back the loan. If the buyer was turned down at the bank, chances are the seller will need to be convinced that the buyer is still worthy of the loan.
- Buyers need to beware of the “due on sale” clause. A due on sale clause is typically included in a mortgage to prevent the homeowner from selling their home before it is paid off. However, if the original homeowner (seller) does sell without the lender’s consent, it could mean that the new homeowner (buyer) is at risk of losing their new home if the lender decides to foreclose on the property.
What are the Pros and Cons of Owner Financing for Sellers?
For sellers, owner financing has the following advantages:
- It’s a great opportunity for a gain on investment. It’s possible that the seller will earn more money from financing the home to a buyer, since they can choose to charge a higher interest rate than a lending institution or bank.
- The homeowner can sell the home “as is”. The seller can possibly avoid having to make costly repairs that they may have been obligated to make if they sell the home in a way other than owner financing.
- The home may sell faster. Because owner financing means that more people potentially have access to financing the home, it means that the home will likely sell faster than it would without the owner financing option available.
For sellers, owner financing may present the following disadvantages:
- The seller would be responsible for taking action if the buyer defaulted on loan payments. Since the seller is financing the loan, they would ultimately be responsible for taking legal action if the buyer stopped making payments.
- The seller would be responsible for any repairs if they take back the property. If the seller ends up taking back the property for whatever reason, they may be responsible for any repairs or maintenance before attempting to sell the property again.
- The seller may face unexpected legal costs. If the buyer defaults on paying back the loan or another problem with the seller occurs, the seller might be responsible for any legal costs associated with dealing with the problem.
Choosing to Go with Owner Financing
Whether you are a buyer or seller, owner financing is a viable option to purchase or sell a home. While there are many different considerations to weigh before choosing owner financing, knowing the basics is helpful so that you can make the best decision for your own situation.
Would you consider owner financing? Let us know in the comments!