Pros and Cons of Owner Financing

Typically your home is the largest single investment a person ever makes. Many people use some type of lender financing to purchase their property. The cost of lender financing is high, and it usually involves some type of creditworthiness, credit scores, and other underwriting guidelines.

Did you know there are other options? One such option is owner financing, which happens when a home buyer finances the purchase directly through the seller – instead of through a conventional mortgage lender or bank.

Owner financing sometimes referred to as “Seller Financing”  is a financing strategy whereby the seller doesn’t hand over any money to the buyer as a mortgage lender would. Instead, the seller extends credit to the buyer to cover the purchase price of the home, less any down payment, and then the buyer makes regular payments until the amount is paid in full.

Here are the steps to owner financing.

  • buyer signs a promissory note to the seller, which spells out the terms of the loan
  • including the interest rate, repayment schedule and the consequences of default
  • owner keeps title to the house until the buyer pays off the loan
  • Much like when you buy a automobile
  • Terms are usually short-term loans, unlike traditional financing

This type of financing could be good for the SELLER and the BUYER. Why? Let’s examine the PROS and Cons from both the SELLER and BUYER perspective.

Pros for buyers:

  • Faster closing – no waiting for the bank loan officer, underwriter and legal department to process and approve the application
  • Cheaper closing costs – no bank fees or appraisal costs
  • Flexible down payment – no bank or government required minimums
  • Good option for buyers who are not able to secure a mortgage

Pros for sellers:

  • Can sell “as is” – potential to sell without making costly repairs that traditional lenders might require
  • Good investment – potential to earn better rates on the money you raised from selling your home than you would from investing that sum other ways
  • Lump-sum option – the promissory note can be sold to an investor, providing you with a lump-sum payment right away
  • Retain title – if the buyer defaults, you keep the down payment, any money that was paid, plus the house
  • Sell faster – potential to sell and close faster since buyers avoid the mortgage process

Cons Of Owner Financing: Although owner financing can be beneficial to both buyers and sellers, it also has some legal, financial and logistical disadvantages:

Cons for buyers:

  • Higher interest –  interest you pay will likely be higher than what you’d pay to a bank
  • Seller approval – even if a seller is game for owner financing, he might not want to become your lender.
  • Due on Sale clause – if the seller has a mortgage on the property, his bank or lender can demand immediate payment of the debt in full if the house is sold (to you). This is because most mortgages have “Due on Sale” clauses, and if the lender isn’t paid, the bank can foreclose. To avoid this risk, make sure the seller owns the house free and clear, or that the seller’s lender agrees to owner financing.
  • Balloon payments – with many owner financing arrangements, a large balloon payment becomes due after five years. If you can’t secure financing by then, you could lose all the money you’ve paid so far, plus the house.

Cons for sellers:

  • Dodd-Frank Act– new rules apply to owner financing: balloon payments may not be an option, you might have to involve a Mortgage Loan Originator (check state law).
  • Default – the buyer could stop making payments at any time. If this happens and he doesn’t just walk away, you could end up going through the foreclosure process.
  • Repair cost – if you do take back the property for whatever reason, you might end up having to pay for repairs and maintenance, depending on how well the buyer took care of the property.

In  Summary: 

Owner financing can help seller the property faster and help buyers owner homes – even if they would be unable to secure a traditional mortgage. There are advantages and disadvantages that both buyers and sellers should be aware of when considering or engaging in an owner-financing arrangement. A qualified Real Estate Broker and  Real Estate Attorney should be consulted to answer any questions, plus write the sales contract and promissory note.

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