Buying a House? The secret of Owner Financing

We all want to get started investing in real estate. But sometimes the credit requirements are too high, and the down-payment needed can bring a tear to your eye. But that doesn’t have to stop you.  Here is a way to cheat the system. The Secret? Owner Financing!

Table of contents

• Owner financing or seller financing
• Types of owner financing
• Advantages of owner financing
• Disadvantages of owner financing
• Ways to structure owner financing deals
• Make it list
• Set the terms
• Make it legal
• Rent it out

Owner Financing or Seller financing

Owner Financing..the magic words.  Namely, the easiest way to go from renting to owning your own home is to cut out the middle man (banks) that have a way of putting a stop to so many dreams.  Basically, the owner becomes the note investor or lender. The owner carries the loan. And you, the buyer, makes monthly payments to the seller.

Types of owner financing

Sellers and buyers are extremely free to negotiate the terms of owner financing. This is subject to state-specific usury laws together with other local regulations; some state laws, for instance, prohibit balloon payments.

While not required, most sellers will expect the buyer to give some sort of downpayment on the property. Their rationale is very similar to any mortgage lender’s. They always assume that buyers who have some equity in a home are less likely to default on the payments and let it go into foreclosure.

Owner financing can take various forms which include the following:

Land contracts

Land contracts are contracts that do not pass the full legal title of any property to the buyer but do give them an equitable title. The buyer will make payments to the seller for a period of time. Upon the final payment, the buyer will the receive the deed.

Mortgages

Sellers might carry the mortgage for the entire balance of the buying price⁠, less than the downpayment, which might include an underlying loan. This kind of financing is called an all inclusive mortgage or all inclusive trust deed (AITD), equally regarded as a wrap.around mortgage. The seller will be able to receive an override of interest on the underlying loan. A seller might equally carry a junior mortgage, in which case the buyer might take title subject to the existing loan or even obtain a new first mortgage. The buyer will receive a deed and will give the seller a second mortgage for the balance of the buying price. This is less than the down payment and the very first mortgage amount.

Lease purchase agreements

A lease purchase agreement, equally known as rent to own, means the seller leases out the property to the buyer. And equally give them an equitable title to it. After he must have fulfilled the lease purchase agreement, the buyer will then receive the full title. Basically he will obtain a business loan to pay the seller, after you have received credit for all or part of the rental payments toward the buying price.

Advantages of owner financing

There are a lot of benefits of owner financing for both the seller and the buyer. Anyone who has ever applied for a mortgage via a bank understand it can be a hassle. A mortgage loan originator will always ask for significant documentation. Seller financing can be a very easy process. That depends on which side of the deal you’re on, here’s some of the things you need to understand.

Pros for buyers

Faster closing time

Because it’s just you and the seller that is working out the deal. You don’t necessary need to wait for the loan underwriter, officer and bank’s legal department to process and approve your loan first.

Less expensive to close

You don’t have bother yourself about traditional lender fees or many of other expenses that are associated with closing on traditional financing. According to Zillow, those costs might even amount to 2% to 5% of the buying price. Understand that’s not to say you won’t be able to have any out of pocket costs, but they’ll relatively be much cheaper.

Credit requirements flexibility

When your credit is much more less than stellar, but your cash flow and reserves look very good. You might have a very easy time to get approved for owner financing arrangement. Than a mortgage loan from a normal traditional lending institution.

Flexibility of down payment

While some sellers might require higher down payments. Some might even offer to take less than what a bank may require for the same financing deal.

Pros for sellers

Can sell as is

With a basic mortgage loan, the lender might have some certain requirements of the collateral (the property) to be able to protect its interests. In some situations, that might even mean that you’ll need to make some costly repairs in order to meet bank loan standards. With an owner financing agreement, there will be no bank to satisfy, and you might be able to sell the home as it is. Thus saving yourself some time and money. (In turn, the buyer might use creative financing like business credit cards in order to fix and flip the property.)

Potentially good investment

This depends on the interest rate you will charge. You might even be able to get a better return on an owner financing arrangement. Than when you were to sell the home for a lump sum payment and invest the money in something else. And unlike the stock market, you won’t have to bother about the return changing based on market conditions. The interest rate will be set for the life of the loan (if that’s how you want to structure the financing terms).

Faster sale

You may usually sell a home faster through seller financing than you might when you decide to involve a traditional mortgage lender.

Keep the title

As the lender, you will retain the title to the home until the buyer will be able to pay off the balance of the loan. What’s more, if the borrower defaults. You will keep the down payment, whatever has been paid to you so far, and the home itself too.

Payment flexibility

As the owner, you might be flexible with the loan terms. You may decide to choose the frequency of installment payments. For instance, you might take monthly payments from the borrower together with a balloon payment in a particular number of years. Or you might even decide to sell the promissory note to an investor and get a lump sum payment.

Disadvantages of owner financing

While there are a lot of pros to using owner financing over a traditional mortgage. There are equally some clear drawbacks that can make you think twice before you enter such an agreement.

Cons for buyers

More costly

Even if it might be very easy to qualify for owner financing than a traditional mortgage loan. Basically you’ll be charged a higher interest rate and pay much more over the life of the loan.

Balloon payment concerns

If you are not able to afford making the balloon payment with your own cash reserves. You might need to get some financing in order to cover the cost. When you don’t do either, you will risk losing the house and all the money you’ve paid up to that point.

No price shopping

With a traditional mortgage, you might shop around and compare rates and other terms on a single home. However, with owner financing, the terms of the deal are strictly set by the property’s current owner. While they’re not always set in stone you might try to negotiate on some points, but you don’t have the option to price shop.

An existing mortgage might be problematic

When the owner still has a mortgage on the property and the loan has a due on sale clause. The lender might demand an immediate payment of the remainder of the principal balance once the sale goes via to you. When neither you nor the owner pay, the bank has the right to foreclose on the home. In order to avoid this, be sure that the seller owns the property free and clear. If not, then consider one of the options below.

Cons for owners

More work

While you might close on the home with the buyer faster than you could with a traditional mortgage loan. Owner financing might require more work in general. When you need to sell your home and be done with it, then the regular process is the way to go.

Potential for foreclosure

When the buyer defaults on the loan but doesn’t still leave the property. You might need to start the foreclosure process, which might get complicated and more expensive.

Potential repair costs

When you end up needing to take back the property. You might be on the hook for repair and maintenance costs when the buyer in question didn’t really take good care of the home.

Ways to structure owner financing deals

When the owner has an existing mortgage loan on their property, it will likely have a due on sale clause attached to it. There are a few situations, however, where the lender might agree to owner financing under some conditions. And there might be other ways to make it happen without even involving the original mortgage lender at all.

Let’s consider a few ways you can structure an owner financing deal when there’s already a loan on the property. As you think about which one is good for you, consider to hire an attorney (like a probate lawyer). To help you in drafting up the agreement to avoid any potential problems down the road.

Rent to own

With a rent to own financing arrangement, the buyer will move in and rent the home. With this portion of their monthly payment that acts as a deposit or down payment. Which they might use to buy the home down the road.

There are various ways to set up a rent to own agreement. For instance, the tenant mighg have the option to puri the home at any point during the lease. Or they might be required to purchase at the end of the lease. When the buyer doesn’t go through with buying the home, the seller might be able to keep the rent premiums. As a result, this might not be a good choice when you’re on the fence or need to avoid the risk of something changing.

Wraparound mortgage

With a wraparound mortgage, you create a loan that’s big enough to cover the existing loan together with any equity the owner has in the property.

You will make the payment on the larger wraparound mortgage. The owner will take a portion of that amount to make the payment on the original mortgage loan. The difference between these payments is the seller financing on the equity portion of the home. The major drawback of a wraparound mortgage is that it’s junior to the original mortgage loan. So whem the owner of the property stops to make payments on the first loan. The lender might foreclose on the home, leaving the buyer so high and dry.

Lease option or lease purchase

With this particular setup, you ultimately will lease the property from the seller with an option to buy it. In some cases, you might even have a contract drawn up to purchase the home at a set date in the future. This option will allow the buyer to ensure control over the property. It may give the owner some time to be able to pay off the original mortgage loan.

Purchase subject to the existing loan

With this kind of arrangement, you will effectively take over the monthly payments on the seller’s mortgage loan. But they’re still legally responsible to make the payments under their contract with the lender. In fact, the lender might not know that you’ve assumed the monthly payments.

This actually means that when you stop to make payments, they’re still on the hook. And it could even ruin their credit when they don’t take up payments again. Additionally, when the holder of a residential mortgage loan becomes aware of this arrangement they might call the loan due immediately. This setup might work if only you have a relationship of trust with the owner. But otherwise, never expect many sellers to be excited about this option because of the increased risk they’re required to take on.

Contract for deed

A contract for deed is a very common option for owner financing. It will work only when the seller owns the home free and clear because the owner will hold onto the property title. While the buyer will be making the monthly payments.

Immediately the buyer finishes the repayment term, which might be whatever the two parties agree to. They’ll be able to receive the deed to the home. Probably they default, however, the owner will still retain the deed and might repossess the home.

Make a List

The same way you can get a used car cheaper by buying it directly from the owner instead of a dealership. It is the same way you would buy a house using this strategy.

First you need to know how much you can spend on a house. The best thing you can do is pick a house  that would have the type of mortgage  payments that are lower than your current rent. This is where you have to do your homework. Not every house is going to be a viable option for you. And not every owner financing situation is opted into by standup owners. Beware of owners that want skyhigh monthly payments… They are setting you up for failure thinking they can foreclose on you and take their property back once you’ve gotten behind.

Secondly, make a list of the houses that fit your financial criteria that are also not being represented by a realtor. Realtor’s discourage this form of selling because they lose their cut. Make sure the owner owns the property free and clear. Don’t be discouraged, at least 30% of properties are owned free and clear.

Set the Terms

Thirdly, this is where you have a chance to shine and to  really get a deal.  This is where you both agree on down-payment or lack thereof, monthly payment, total cost, term in years. Maybe you can finesse your way into no down payment with 5% interest for 15 or 30 years. Typically, owners want as few years as possible but if you can work your magic on them, they may extend the period of payment.  Just make sure you are completely comfortable with the terms. Remember, people are easier to convince than corporations.

Make It Legal

Fourthly, the paperwork has to be filed. For your protection as well as the owners. You will have a mortgage agreement set up with the owner operating as the lender.  Then you make your payments. Here’s a tip. Make your payments for 2 or 3 years and go back to the seller and tell them you will give them half of what you still owe them in order to close it out and be free and clear.  So instead of owing another 20 thousand on the house, offer them ten thousand and now you own the house, no mortgage!

Rent It Out

And finally…

Yeah, you could live there. Or you could stay in your tiny apartment with the cheaper rent and rent the house out for more money than your payments. That way, you pay your mortgage, your property gains equity, and use any extra you make to further invest or to fix up the home you bought…in case you are on your way towards flipping.

What are your thoughts?