What Is Home Finance by Owner?

What Is Home Finance by Owner?
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Whether you choose to purchase real estate sold through a real estate owner or for sale by owner (FSBO), you'll need to go through some type of financing process unless you're buying the house entirely with cash. While the traditional route for a home loan involves going through a lender who qualifies you and pays the seller the funds, this option might not work if you have issues with your credit, income or a lot of existing debt. Seeking a seller willing to offer you owner financing can help you with your purchase in such situations. Use this guide to learn how it works, which forms of seller financing exist and what to know about considering your options.

Looking at Traditional Home Financing

Most home financing occurs through banks and credit unions that offer various mortgage loan programs to homebuyers. The financial institutions acting as lenders assume the risk as they will provide the funds for the homebuyer to purchase the home.

For their security, lenders will use the house as collateral so they have the option to foreclose on the property if a borrower doesn't hold up their agreement to make mortgage payments. As the borrower makes payments of principal and interest, equity builds up in the property. After a typical term of ​15 to 30 years​, the borrower finishes paying off the mortgage.

Mortgage terms and requirements such as fees, down payment amounts, interest rates, minimum credit scores and other factors all depend on the lender and mortgage program. So, a borrower may qualify only for certain programs or none at all, especially if they don't have a high enough income, have a poor credit history or struggle with debt. While options such as the Veterans Affairs (VA), Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) loan programs can help buyers who lack down payment funds or have a trickier credit situation, the need to seek an alternative type of home financing can still arise.

Understanding Owner Financing

Seller financing comes in various forms, but they all involve the seller becoming the lender and thus assuming the risk that comes with lending a buyer money for a property. The seller has the job of determining the requirements for the mortgage such as a minimum down payment, income and credit score along with the terms like the length, interest rate and loan amount. They also collect payments directly from the buyer unless they hire a third-party service to help with the task.

In some forms of owner financing, the buyer doesn't actually become an owner right away and goes through either a rental period or period of shared ownership with the seller. Other forms involve a purchase agreement upfront with the expectation that the buyer will eventually get a regular mortgage to pay the seller a large sum of money after a specific number of years. For their protection, the seller will usually hold onto the deed until the buyer has fulfilled their payment agreement.

Going with owner financing can appeal to home buyers who wish to avoid some of the hassles and stricter requirements of a traditional mortgage, want to face lower closing costs and prefer a speedier process. Sellers might opt for offering owner financing if they want to speed up the time it takes to sell their homes and they feel fine taking on the risk that comes with lending a large sum of money to the buyer. However, a seller financing agreement works best when the seller doesn't have a mortgage anymore since otherwise the lender would need to approve of the arrangement and more risks arise for both parties.

Considering Land Contracts

One type of seller financing involves the seller arranging to share ownership of the property for a period of time, and the buyer will eventually get the title and become the full owner. Called a land contract, this arrangement helps people who need time to work toward qualifying for financing since making monthly payments for several years under the contract can help demonstrate responsibility when the buyer seeks a mortgage at the end of the contract period. The money paid during the contract period goes toward the property's purchase price, but sellers may charge a higher price to compensate for the arrangement.

Since you wouldn't have the deed to the property during the contract period, going with this owner financing option requires careful consideration. For example, the contract you sign can have provisions that mean losing thousands of dollars for your down payment if something happens where you miss a payment or if you fail to obtain financing when the contract period ends. You can also run into legal issues if something goes wrong with the seller as well as disagreements over who makes repairs to the property during the shared ownership period.

Exploring Mortgages from the Seller

In other cases, the seller might draft a mortgage agreement with their own terms and lend you either part or all of the money you need to purchase their home. Due to the Dodd-Frank Act, this option can sometimes require that the seller has a license to offer financing, but this might not apply as long as they're the homeowner meets certain conditions. These types of owner-financed loans can offer a short-term solution if you need some time to prepare your finances to get qualified through traditional lenders, but some sellers might allow you to finance through them until you've paid off the whole purchase amount.

When a seller offers a full mortgage for the property, you'll usually make a down payment, and the owner will calculate principal and interest payments for an agreed-upon period of time such as ​10 years​. While the term may be short, the payments may be calculated as if you've taken out a standard 30-year mortgage. But after you finish making monthly payments to the seller for the agreed term, you'll often need to make a balloon payment equal to the remaining balance. If you can't afford to pay that full amount in cash, you might go through the mortgage application process with a traditional lender so that the seller can get their money.

If you can qualify for a traditional mortgage but just can't get enough money to cover the whole home purchase price, the seller might instead offer to finance the remainder through a second mortgage, and you'd pay them monthly for the arrangement. A seller can find this a less risky option – which is sometimes called carryback financing – since they'd at least get the proceeds from your first mortgage upfront. However, they still take on the risks of a second mortgage and the chance that they might not get their money if foreclosure occurs due to your nonpayment.

Examining Assumable Mortgages

As an alternative to getting a mortgage directly through the seller, you might find sellers willing to allow you to take over – or assume – their mortgages so that they no longer are responsible for the debt and you won't need to seek a new mortgage yourself. You'll most often find this option suitable when the seller has a government-backed mortgage such as an FHA, USDA or VA loan, and specific requirements can apply to the person taking over the mortgage. For example, the seller's lender will have to make sure you meet the requirements such as a high enough credit score, stable income and acceptable debt-to-income ratio for the loan program.

Depending on how much value the property has and how long the seller has made payments on the loan, assuming their mortgage can require having a large amount of money to hand over as a down payment. Most often, you'll find a significant difference between the remaining mortgage balance and the home's property value as the owner has built up equity and housing prices have risen. For example, if you want to buy a $300,000 home from the seller and their mortgage balance is $200,000, then you'd need to provide the seller with $100,000 for the down payment through your savings or through a bank loan you obtain separately.

This option differs from other seller financing methods in that once the sale has completed and you've paid your down payment, you won't have to have financial transactions with the seller anymore. You'll start making your mortgage payments to their lender since the loan will be transferred to your name. As a result, this arrangement will usually involve a mortgage application process, but certain requirements like an appraisal might get waived.

Learning about Rent-to-Own Arrangements

If you're not yet ready to purchase a property and would rather rent a home for a period of time before the purchase step occurs, then another seller financing arrangement exists in the form of a rent-to-own agreement or lease option. With this option, the home's owner sets up an agreement where you will be a renter – usually for ​up to five years​ – and at that time you'll proceed to purchase the property from the seller. At least a portion of the rental payments you've made will usually get credited to the purchase price.

When the rental period expires, the owner might provide you with a mortgage, or you might seek one traditionally through a lender. You usually pay an option fee from the beginning to receive the purchase benefit from the deal. In some cases, the seller might just make the purchase an option so that you don't face legal issues if you fail to obtain financing to proceed with the purchase.

Since the home's owner as seller carries the risk that you might not end up buying the property once the rental period expires or that you could damage the home and harm its value during your rental period, they usually have you sign a document upfront where you promise to proceed with the purchase. This can include agreeing to buy the home for a specific amount of money, or it might have a provision that you'll pay whatever market value the home has in the future as a buyer default.

Moving Forward with Seller Financing

If owner financing appeals to you, you'll need to locate a property with a seller willing to allow for one of these arrangements. Often, these homes are listed as FSBO and have listings that address seller financing as an option. You can get the help of a real estate agent for your search for such properties.

You'll then need to consider the specific costs and requirements as well as understand your rights as a buyer. Therefore, it's helpful to hire a real estate attorney during the process since they can help you understand the financing terms of a seller financing agreement and help protect you from issues that can arise.

You'll want to learn about the owner's requirements upfront since they can still request a credit check, look at your debts and income and require a hefty down payment for you to qualify for many of the seller financing options. Sellers will often want documentation, and lacking in one of the required areas might mean a higher interest rate or rejection. You'll also want to prepare to negotiate loan terms such as the interest rate and any period before a balloon payment, a form of lump sum payment, as well as ensure you'll be financially ready to get a traditional mortgage from a traditional mortgage lender at the end of the agreement, if necessary.

Navigating the Owner Finance Process

Going through the seller financing process as a borrower usually involves a loan application that can seem a lot similar to what a traditional lender requires. The seller will look at all your financial data, compare it to their requirements and then either approve or deny you. If you get approved, then you'll need to take a close look at the promissory note as this will indicate everything from the length of the loan and interest rate to all the conditions that come along with the agreement. Pay special attention to any requirement for a balloon payment or actions that might invalidate the agreement and cause you to lose money or the property.

What happens next depends on the form of seller financing used. Most often, the seller will handle any necessary mortgage recording after you've both signed the promissory note, you've made any required down payment and you've paid any requested fees. You'll then need to pay the seller monthly mortgage payments according to the repayment schedule. Eventually, you'll likely go through the traditional mortgage application process unless the seller will let you keep making monthly payments until the home's completely paid off.