If you're offering owner financing on your house, there are a few factors to consider. Owner financing can be an excellent way to take a house that isn't selling and get it moving forward since it opens the property up to people who may have trouble qualifying for a traditional loan -- like buyers with borderline credit and investors. It can also offer you tax-deferral benefits. Despite these benefits, you take some real risks.
There are three ways to offer owner financing. The most favorable for you is usually the lease option, in which the buyer rents the house from you and pays extra money both up front and every month that gets credited to the purchase price. If he doesn't buy the house, you usually get to keep all of the extra money that he paid. In a contract for deed , you hold the legal title and the buyer holds equitable title. In exchange for making monthly payments to you, he gets all of the rights and responsibilities of homeownership and, when he pays you off, he gets the title. Under a contract, he has the right to sell the house. Another form of owner financing is when you carry a mortgage. In this instance, the buyer owns the house and you have the same rights as any other lender. As long as he makes his payments, you're fine, but if he doesn't, you'll have to pursue foreclosure proceedings.
Let's Make a Deal
Buyers like owner financing because they can negotiate terms that work for them -- something that's usually hard to do with a traditional lender if they aren't particularly well qualified. The ability to negotiate also applies to you. If you need a longer loan term, or want to only get paid interest, or if you want a higher interest rate, you can negotiate for it. This flexibility can be valuable.
When you finance a property for a buyer, you take the risk that he might not make his payments. If he doesn't, you'll have to take the home back using whatever measures are available to you under your state's law and your particular type of financing. You also take the risk that the buyer doesn't maintain the house or that he vandalizes it before returning it, leaving you with expensive repair bills.
Tax Deferral, Not Avoidance
When you finance a property for the buyer and get a little bit of principal back every year, you get the opportunity to spread out the capital gain that you receive from the property, as well as the capital gains tax that you pay, over time. The exception to this would be if your adjusted gross income is over $200,000, filing individually, or $250,000, filing as a joint couple. Then you'd be subject to the 3.8 percent investment income surtax. Consider, too, that your gain might not be taxable at all. If you lived in the house as your primary residence for two of the past five years, you're generally allowed to enjoy your first $250,000 of profit, or $500,000 if you're married, tax-free.
- Nolo: Seller Financing: How It Works in Home Sales
- Inman News: Seller Financing for Today's Market
- Owners.com: Perils Of Seller Financing
- Frascona, Joiner, Goodman and Greenstein, P.C.: Tax Benefits of Seller-Carry Financing
- National Association of Realtors: The 3.8% Tax Real Estate Scenarios & Examples
- IRS: Publication 523
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.