Is Owner Financing Right For Me?
Owner financing, sometimes called seller financing, is a little-known method of home financing that can help people who don't qualify for a traditional mortgage to buy a house. In an owner-financed transaction, the seller lends the buyer the money to buy the house, avoiding the issues of dealing with banks, closing delays, and closing costs. Owner financing allows a great deal of flexibility in setting down payment and interest rates and helps sellers dispose of properties that might otherwise be difficult to move.
Why Would The Seller Loan Money To The Buyer, Just To Pay Himself?
Owner financing is easiest to understand when we compare it to car dealers who lend money to car buyers to get them to buy a car they can't afford. The car dealer (or the car dealer's finance company) will issue a loan with a schedule of payments so that the buyer can afford the vehicle. If the buyer keeps up with his monthly payments, he keeps his car. If the buyer stops paying his monthly payments, the car is repossessed. The dealer gets the car out of his inventory and makes a profitable sale.
Similarly, the home seller will issue a loan and mortgage to the buyer to help pay for the house. If the house buyer keeps up with his monthly payments, he keeps his house. If the buyer stops making monthly payments, the house is foreclosed. The seller wants to sell the house as quickly as possible, and this is one way to make the sale as fast, cheap and painless as possible.
So How Is This Different From A Normal Mortgage?
A normal mortgage issued through a bank or mortgage lender has to comply with a whole list of rules, procedures, and criteria. The borrower will need a good credit score and stable employment to get a reasonable interest rate and down payment. The lender wants assurance that they will be paid back on time. The seller, on the other hand, just wants to sell the property as quickly as possible, even to someone with a flawed credit rating.
Wait, It Can't Be That Simple!
It's not. There are a bunch of potential trouble spots that both buyer and seller have to consider when owner financing. Chief amongst these is that the seller must own the house free and clear, with no existing mortgage. Many mortgages have what is known as a “due on sale” clause, where the whole mortgage becomes due if the house is sold. If a “due on sale” clause is triggered and the seller can't pay, the seller's mortgage lender will foreclose on the property, and neither buyer nor seller will have a house. A seller who has already sold the house may default on his existing mortgage, causing the buyer to lose his house.
That list of rules and procedures that the mortgage lender follows protects the buyer, the seller, and the lender. By avoiding the bank and their rules, both buyer and seller lose protections that they must now perform themselves. Things like title search, credit rating with background and references checks, property appraisal, home inspection, mortgage insurance, etc. are built-in to the costs of closing, something both buyer and seller are hoping to avoid. If you choose owner financing, you'll have to do those jobs yourself or hire a lawyer to do them for you.
Types Of Owner Financing
Owner financing is very flexible, and several scenarios can occur, as well as some variants. These are the most common types of owner financing:
All In One Mortgage (All In One Trust Deed)
- The seller carries the loan on everything but the down payment. The buyer gets ownership and makes monthly payments to the seller.
- The buyer has some financing, but not enough to buy the property outright. So the seller loans the buyer a smaller second mortgage (a junior mortgage) so the buyer can afford the property. The deal could include financing of the down payment, or even substitute for a down payment. The buyer gets ownership and makes monthly payments to the seller. If the borrower defaults, the junior mortgage is only paid off after the main financing, which makes the junior mortgage a bit of a risk.
- The lease option is a Rent-to-Own arrangement, where the lessee pays rent with the option to buy (within a certain short term) and to apply a premium over the standard rental towards the purchase price. In this case, the landlord is the owner until the buyer has fully paid the agreed price for the property. An advantage is that the purchase price is locked in for the option period. A disadvantage is that if the lessee is evicted or the lessor foreclosed against, any payments already made can be lost.
Assumption of Mortgage
- The buyer pays some part of the purchase price, assumes ownership, and takes over the seller's existing mortgage. Some mortgages allow for this; some don't.
- The owner loans money to the buyer, who repays in installments. The buyer has some rights but is not the owner. The contract would require a lawsuit/judgment to become enforceable.