Buyers who can’t get a mortgage loan often rely on owner financing until they qualify to refinance the loan through a bank or other mortgage lender. Although owner financing can be a viable alternative for selling a home faster and typically involves fewer costs to the buyer, the process can be risky to buyers and sellers. There are both financial and legal implications associated with sellers financing a mortgage.
Losing Interest Paid
Like other mortgage loans, a buyer of an owner-financed home must pay back the loan with interest. Because the home's owner is assuming the risk, you may have to pay a higher interest rate than a bank might offer. Buyers with credit problems who do not qualify for a mortgage loan at a bank may have no choice. Another problem is that a seller generally extends a buyer credit for a much shorter loan term than a traditional mortgage lender. If a buyer is unable to finance the balloon payment that falls due at the end of the repayment period, he can lose the interest he has paid on the loan.
Existing Mortgage Stipulations
Sellers who no longer have a mortgage on their homes are more likely to offer seller financing. The process becomes more complicated if the seller still owes a balance on an existing mortgage loan. In this case, the seller’s mortgage lender must agree to the terms of an owner-financed sale. However, many lenders are unwilling to take the risk. Most times, a seller’s mortgage agreement stipulates that the mortgage must be paid in full when the property is sold. Unless a buyer can make enough of a down payment so that the seller can pay off any remaining mortgage balance, the seller’s own mortgage agreement may disallow a sale that involves owner financing.
Unable to Refinance
It's essential to get all the provisions for financing in writing – especially in regard to financing once the balloon payment comes due. Both buyer and seller sign a promissory note detailing the terms of the loan. A written contract should clearly describe the terms between buyer and seller explaining each party’s rights and obligations in case there are problems later on. Include the sale price of the home, amount of the loan, interest rate, loan term and what happens in the event the buyer defaults on the loan. Buyers can further protect themselves by including options in the loan contract for extending the term of the loan or making graduated loan payments if they can't get refinancing when the time comes. If you don't, you risk losing not only the interest payments but also the down payment, monthly principal payments and any other money you've invested in the property during the term of owner financing. A graduated payment schedule allows the borrower to increase monthly loan payments over time.
Seller Holding Title
Most sellers who owner finance extend credit for a term of three to five years with a large balloon payment due at the end. The seller continues to hold title to the property until the buyer’s loan is paid in full. This puts buyers in the position of having to improve their credit scores within that period so that they can get a conventional mortgage and pay off the seller. In the meantime, the seller still controls the title to the property and can possibly accumulate other debts against the property before the buyer pays the full purchase price and the deed is released. Just as with a bank, if you pay late or default on the loan, the seller has the right to foreclose or take the property back.
- Bankrate.com; Will Seller Financing Sell Your Home; Lerner; September 2010
- MSN Real Estate; 4 Alternatives to a Traditional Mortgage; Fontinelle
- CNNMoney.com; Rent-to-Own Your Home – Pro and Con; Christie; June 2009
- 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.
Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering business and finance, health, fitness, parenting and senior living issues for both print and online publications. Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.