Buying or selling a home is such an exciting adventure, and there are few things more frustrating than not being able to make the sale because either the bank won’t work with you to secure your loan, or the house you’ve put on the market isn’t bringing the buyers in. As a buyer, maybe you’ve tried to be financially responsible, but life hit you hard and your credit score took the damage. Perhaps you’ve met with every lender in your area, including the ones you knew were a gamble, but no one was willing to give you a chance. As a seller, maybe you listed your property because you couldn’t afford not to, but the market isn’t great, and your home isn’t attracting enough buyers. Maybe you’ve read every rule about how to get your home noticed and followed every rule in your listing, but it feels like there just aren’t enough buyers to go around.
For either situation, owner financing could be the solution you’ve been waiting for.
How Does Owner Financing Work?
The concept of owner financing is simple: rather than approach a financial institution for a mortgage, the seller agrees to carry the loan for the buyer. This means the buyer would pay a down payment and make monthly payments directly to the seller including whatever interest is agreed upon in the contract. The buyer would receive the contract, or promissory note, as evidence of conditional ownership. The seller would retain a second document that details any repossession conditions should the buyer default on the agreement.
Owner financing is not common among homeowners but there are a few scenarios that could make a seller more open to the concept. If a property is free of mortgages or liens, offering owner financing will allow the seller to benefit from interest payments, increasing the total profit. A property that has been on the market for a while can also be a good candidate for owner financing if the seller is impatient to be rid of it.
Types of Owner Financing
If owner financing seems like a good option, it’s important to understand the three standard types of owner financing so you can determine which type works best for you.
Agreement for Deed, Land Contract, Contract for Deed: In this situation, the buyer would not receive legal title until the terms of the agreement are fulfilled. Instead, the buyer would take possession of the property and would be given an equitable title. As a buyer, if you were to default on your payments, the seller would be able to repossess the property with relative ease because they would still hold legal title until the loan were paid in full.
Deed of Trust, Trust Deed: This scenario requires three parties to carry out. The buyer would be the trustor or borrower, the beneficiary is the seller or lender, and the trustee would be a neutral third party, such as an attorney or a title company chosen by the seller. Here, the property’s equitable title would be transferred to the buyer, allowing full possession and promised ownership of the property. The legal title would be transferred to the trustee along with the power to initiate the foreclosure process should the buyer default on payments.
Lease Purchase, Lease Option: These financing types are more commonly known as rent-to-own. For the lease option, the seller creates a lease agreement and an option agreement with the buyer. The option agreement will be set for a designated time in the future and will list the terms and conditions required for the buyer to purchase the property. In this case, the buyer is under no obligation to make the purchase and can simply walk away at the end of the lease. In a lease purchase agreement, the buyer has already agreed to complete the sale and is required to follow through. In both cases, the lease payments are either held to cover the down payment and closing costs, or to offset the purchase price.
Why Would Someone Need Owner Financing?
Owner financing is a great solution for buyers who are unable to obtain a conventional mortgage from a financial institution. Buyers who have credit scores that are below the qualifying threshold, or those with collection debts they are unable to clear, may find they have better luck with a private agreement directly with the seller. Owner financing is not subject to the rules of corporate banking so there can be more flexibility when drawing up the agreement. In contrast to the standard credit score cutoffs that most financial institutions rely on, the seller can look at applicants as individuals to make their decision.
For example, if a family has a history of paying their bills on time but have a low credit score because of unforeseen medical bills that went to collections, a seller may determine that their low score doesn’t affect their creditworthiness and engage in the sale with them anyway.
Buyers who are struggling to save a down payment could also benefit if a seller would be willing to break the down payment up into installments. The rent-to-own options could help with this as well as buyers who want to “test drive” the property before committing to a purchase.
Benefits of Owner Financing
Owner financing can benefit both the buyer, and the seller in a sales transaction. For the buyer, the biggest benefit would be the ability to purchase a home if poor credit or other circumstances prevent approval for a conventional mortgage. It could also save the buyer some cash up front if the seller were willing to take a lower down-payment than what is standard in the industry. More money is saved with reduced closing costs by cutting out the financial institutions. Loan originating fees and loan discount fees become unnecessary and an assessment of the property won’t be needed because the seller already knows the value.
For the seller, offering owner financing can be a good way to renew buyer interest in a property that has been on the market too long and bring in new buyers who may not have been able to meet the terms of their financial institutions. Sellers also see their profits go up because all interest paid goes directly into their pocket rather than to a lending institution.
For both parties, owner financing offers flexible terms. Without the corporate rules that govern lending practices at banks, both parties are free to draw up whatever arrangement they see fit as long as they both agree. Extenuating circumstances and special considerations are much easier to handle between both parties if there are no protocols to follow. An agreement involving owner financing can also be written more clearly, making it easier to understand, and will involve less paperwork without the additional documents required by the banks. Finally, it is possible to close the sale much faster without the need to cater to the timetable of a financial institution.
Shortcomings of Owner Financing
On the other hand, owner financing is not without risks and downsides. Despite the elimination of excess paperwork, the actual process of handling the transaction can seem more complicated without an established system already in place. Although banks can be difficult to work with, they generally have a proven set of procedures that they go through with each loan they finance to make sure everything is covered. Without them, the buyer and seller are left on their own to verify all requirements are met. This also means, if a mistake is made, the parties are not covered by the guarantee a bank offers that the sale will be done right. Without a third party to seek restitution from, the buyer and seller must sort it out amongst themselves. For this reason, it is sometimes necessary to have an attorney draw up the agreement. This becomes an added expense that could offset some of the financial benefits of an owner financing arrangement.
It is also possible that a buyer could find themselves in a position where they are unable to convince a seller that they have the means to pay for the property. Rather than have a set of established rules to determine loan eligibility, seller will often have differing opinions on what qualifies as proof of payment ability. This situation could require the buyer to share more personal information with the seller in an effort to prove their creditworthiness which also presents a privacy issue. Sellers are not beholden to the same privacy rules that govern financial institutions so any personal information that is shared is not necessarily protected. Even if the seller has the best of intentions, their efforts to keep your information secure may not be enough to keep you from being compromised.
Finally, as a buyer, you could end up paying more for the property than you would with a conventional loan. Not all sellers are honest and, if you happen to be a buyer that is unable to qualify for a conventional loan, some sellers may decide to capitalize on that. You could be faced with much higher interest rates than are acceptable in the industry with no protection other than regulations placed by your state’s laws. Sellers could also decide to raise the asking price if they see you have limited options or have an immediate need to purchase their property. You may even be tempted to agree to unfair costs because you worry that this is the only way you will be able to buy a home and an unscrupulous seller will capitalize on that. In the end, buyers may find themselves paying significantly more just for the privilege of having an option to buy.
The Bottom Line
For buyers who are struggling to qualify for a conventional mortgage, owner financing could be the solution that allows them to purchase a home that would otherwise be out of their reach. This type of financing eliminates the need for financial institutions and allows parties of the sale more control over the terms of the agreement. Sellers with property that isn’t selling may find that offering to carry the loan attracts the interest of more buyers, thereby increasing the chance for a sale, and both parties could stand to benefit financially. Sellers can receive the interest payments that would traditionally go to the bank and buyers can save on closing costs with the elimination of loan fees.
There can also be downfalls to consider when opting for an owner-carried loan. There is less protection for both parties if mistakes are made, privacy issues concerning sensitive personal information, and a learning curve when it comes to navigating the sale itself. Everyone involved in the transaction takes on the responsibility to do their due diligence to protect themselves and ensure the agreement they are making follows the laws of their state. The consequences of making a mistake in the agreement falls on the buyer or seller rather than on professionals from a lending institution.
Many of the potential negative consequences associated with owner financing can be avoided with a little careful planning. Buyers should identify the type of financing that works best for their situation and should be on the lookout for sellers that seem to be taking advantage of their situation. Both parties should spend some time learning the laws surrounding owner financing in their area and research how to keep the agreement compliant with related regulations. Buyers need to calculate the actual value of the property to ensure they are not agreeing to an inflated asking price and sellers need to ensure they are protected by the agreement, and state law, should the buyer default on payments.
If both parties take the time work together for a mutually beneficial agreement, owner financing can be an excellent alternative to conventional loans. Not only can the agreement be tailored to meet specific needs, both parties can work with each other throughout the life of the loan so that each gets what they need in the end. If you’re having trouble getting approved at the bank, or you have property on the market that just won’t sell, owner financing could be the solution you’ve been waiting for.
Call The Wright Choice Team today at 804-307-2589 to tour available homes for sale in the Chesterfield County area.