Explaining owner financing is a little like defining a cross-country drive. Anyone who undertakes such an adventure will travel coast to coast, but there are a lot of different ways to get there. One-size-fits-all facts about owner financing can be hard to pin down because these deals are uniquely tailored to the individuals involved. In most cases, buyer and seller can negotiate their own terms and structure their transaction however they like.
How It Works
Owner financing places a homeowner in the role of mortgage lender. Just as with a traditional mortgage, the owner holds a promissory note, and the mortgage – or deed of trust in some states – is recorded. The buyer enjoys use of the home and makes payments on the loan. His payments go directly to the seller, however, not to a third party lending institution.
An owner trying to sell his home might agree to finance the entire purchase price, the purchase price less a down payment, or only the down payment. Traditional lenders often look for 20 percent down. A 20 percent down payment on a $300,000 home would require that the buyer have $60,000 in available cash, plus closing costs. If he does not, the seller could agree to finance $60,000, or a portion of $60,000, to help the buyer qualify for a traditional mortgage more easily. When a seller finances a down payment, the first mortgage lender typically requires something in writing ensuring that the seller is the junior lienholder. In the event of foreclosure, the first mortgage lender would be paid first from the proceeds of a foreclosure sale.
Other forms of owner financing include land contracts and rent-to-buy contracts. In both cases, the buyer makes his payments to the seller, just as he would if the seller were financing the entire purchase price or the down payment. With a land contract, however, the buyer does not receive title until the loan is paid off. In the meantime, buyer and seller effectively share ownership of the property. Rent-to-buy contracts are actually leases where some or all of the rent payments go toward a home's purchase price when the buyer can eventually close on a traditional mortgage. In this case, the buyer has no ownership interest in the home until he actually purchases it.
Considerations for Buyers
Owner financing might seem like a buyer's dream-come-true, but it does come with a few potential pitfalls. Sellers are typically not willing to finance 30-year loans; they want to cash out of their homes much more quickly than that. They often require a balloon payment at the end of five, 10 or 15 years – the entire loan balance comes due at that time. If you're the buyer and you can't refinance through a conventional mortgage at that time, you could end up losing your home. Owner financing does not eliminate the risk of foreclosure. If you can't make the payments and you default on the loan, the owner can proceed with this legal remedy just as a bank can.
Considerations for Sellers
Some owner-financing downsides exist for sellers as well. If you finance the entire loan for your buyer, you won't receive a lump sum of cash which you can then use to purchase another residence. If you have a mortgage against your property, you'll probably need your lender's approval for the deal, because you must make your own mortgage payments out of the payments made to you each month. Depending on the economy, banks may not be willing to take on this risk. Owner-financing arrangements are most workable when you own the property you're selling free and clear of any encumbrances.
- MSN Money: Is Seller Financing Right for You?
- The Wall Street Journal: The Pros and Cons of Financing a Mortgage
- Presti & Naegele: The Pros and Cons of Owner Financing
- Nolo: Seller Financing – How It Works in Home Sales
- Nolo. “Seller Financing: How It Works in Home Sales.” Accessed March 9, 2020.
- New York State. “Real Estate License Law,” Page 37. Accessed March 9, 2020.
- Federal Reserve Bank of St. Louis. “Local Predatory Lending Laws: Going Beyond North Carolina.” Accessed March 9, 2020.
- Cailber Law, S.C. "Land Contracts.” Accessed March 9, 2020.
- California Legislative Information. "Article 3. Disclosures on Purchase Money Liens on Residential Property." Accessed March 9, 2020.
- LendingTree. “Your Guide to Rent-to-Own Homes.” Accessed March 9, 2020.
- IRS. “Topic No. 705 Installment Sales.” Accessed March 9, 2020.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.