What is Owner Financing?
Owner financing is a financing arrangement in which the seller “homeowner” agrees to accept monthly payments directly from the buyer rather than having the buyer get a new loan from a bank. Owner financing is a useful tool that provides the buyer with easier qualifications than a traditional mortgage while providing sellers with monthly income. It basically makes the seller into the bank giving them a better return on their house than selling it for straight cash.
What Owner Financing Is & How It Works
Owner financing otherwise known as seller financing is an option you can use to purchase real estate when you otherwise can’t get a traditional mortgage. With a traditional mortgage, you borrow money from a bank at a set interest rate and time frame to pay for the property. Then, you make payments back to the bank based on the agreement you made with them to pay it back. With owner financing, you make arrangements to pay the homeowner instead, typically of principal and interest just like the bank, until you’ve paid off the purchase price of the property with interest.
An owner-financed transaction involves a fair amount of legal paperwork to be created. But it isn’t that hard once you get an understanding of how it works. Below, we’ll talk about promissory notes along with mortgage documents and deeds of trust. This paperwork is fairly standard and used in both traditional and owner financing closing; more importantly, it protects everyone involved buyer and seller.
Owner financing isn’t just for real estate investors, owe no. It can be used by just about anyone, and for any type of property from a single-family home to an apartment building or even a piece of raw land. It is a great way to buy and sell property all over the United States and Canada.
Throughout the country, owner financing is called many names. You may hear it referred to by one or all of the following terms:
- Owner financing
- Seller financing
- Owner carried financing
- Owner carry back
- The owner will carry (OWC)
These all mean basically the same thing; there are just some regional differences in what owner financing is referred to. Kind of like a bathroom. Some call it a water closet, The Can, little boy or girls room, or even The Throne Room. You the the picture.
Let’s look at a basic example of how owner financing works.
An Example of Seller Financing
Let’s say you found a house for $100,000. You could go to the bank and borrow $100,000 to purchase the house. However, let’s say that you can’t do that. Perhaps your credit is not stellar, you are self-employed or a contractor and have difficulty verifying your income, or you already have a lot of debt and have topped out what you can borrow. Whatever the reason, let’s just say you just can’t borrow money the traditional way. Let’s also assume you don’t have $100,000 in cash lying around to buy this house.
In this case, let’s say you could offer to the seller the following: instead of buying the property for straight cash or from the proceeds of a bank loan, you propose making monthly payments to them. Those payments will include principal, and 7% interest and will be for the typical 30 years. The numbers would look like this:
Seller Financing Example
|Number of Payments||360 (30 years worth of monthly payments)|
|Monthly Payment (Principal and Interest)||$536.82|
|Total of All Payments to Seller||$193,255.78|
Typical Owner Financing Terms
The above example is a very, very simplified one. However, this isn’t what typically happens with most owner-financed deals. In most owner-financed deals, you’ll probably have to put a down payment on the house, loan periods (amortization periods) will range from 10 to 30 years, and sometimes there is a balloon after a set amount of years. Usually from 3 to 5 years in.
Here’s what you can expect from each:
While there’s been a lot of discussion over the past 3 or 4 decades about “nothing down” or “no money down” that is not a common occurrence. To the Homeowner, a down payment is your “skin in the game”; it’s what you will lose if you default on your payments. So, you can expect the homeowner to ask for 5% – 25% (and sometimes more) for down payments. It is all based on the house and the seller’s trust in the new buyer.
Now just because a seller may ask for a hefty down payment, does not always mean it is written in stone. Unlike working with a bank or financial institution, when you do seller financing, there’s often room for negotiation.
Most people are used to a 30-year mortgage, and it has only been recently, with historically low-interest rates, that some people have started to go with 15-year payback periods (15-year amortization) to pay off their homes faster.
With most owner financing, you won’t typically get 30-year amortization periods because sellers normally won’t want payments slowly coming in over 3 decades. While a 30-year amortization schedule is possible, expect the loan to have a balloon after 3 to 5 years (see below). Otherwise, expect amortization periods normally in the 15 to 20-year range.
When a longer amortization period is offered or the seller doesn’t want to hold the note for a long time, The sell will put in a clause called a balloon payment. With a balloon payment, the entire remaining balance is due in full at some period of time before the end of the normal payback period.
So let’s use the example from the table above. Instead of accepting payments for 30 years, The seller agrees to use the 30-year payment schedule but wants a balloon payment at the end of 10 years. This means the seller is not interested or sometimes able to drag out those monthly payments past the 10-year mark. Now this means, you must pay off any remaining balance after 10 years with cash or by getting a new loan.
In the example above, a balloon for the remaining principal balance at 10 years would be about an $85,000 lump sum payment.
More Realistic Owner Financing Terms
Let’s look at a more realistic owner-financed scenario that involves both a down payment of 10%, a 30-year amortization period, and a balloon for the remaining balance due in year 15.
More Realistic Seller Financing Example
|Down Payment (10%)||$10,000|
|Amortization||30 year repayment schedule|
|Balloon||At 15 years|
|Monthly Payment (principal and interest)||$483.14|
|Balance Due at Time of Balloon||$63,329.75|
|Total of All Payments to Seller (down payment + monthly payments for 15 years + balloon payment)||$190,233|
Now keep in mind that when the balloon comes due, you either have to come up with $63,329 in cash to pay off the balance or go to banks and refinance the house to pay off the seller.
Typical Owner Financing Documents
In order to complete an owner finance transaction, You will need 2 types of documents. One is called a promissory note which spells out the loan terms and the payment terms. The other will be either a mortgage document or something called a deed of trust which provides security for the loan.
Promissory notes are not difficult to understand. They are your promise to repay the debt. The promissory note will specify:
- Amount of Borrowed Sum
- The term of repayment
- The interest rate
- The repayment schedule (amortization scheduled),
- Payment amount and whether it is principal and interest or takes another form
- Whether a balloon payment is involved and what those specifics are
Promissory notes will also provide the terms of the penalties if you are late on payment if early payoff involves any additional costs (some loans have a penalty if you pay them off to soon), and whether the loan will have a due-on-sale clause. A due-on-sales clause means that if you sell the have you have to pay the loan off.
Both buyer and seller can hire an attorney to draft the promissory note and other documents if you choose to, or you can use an online legal service or title company.
If you need a promissory note written, Patriot Title Company could be a good option. They are a great Title company that provides the wonderful Title company with lots of legal business experience. Ojay Grace is a great attorney who will let you know what Texas requires for a valid promissory note. They will even draft it up for you.
Patriot Title Southwest
8306 Bob White Drive
Houston Tx, 77074
Mortgages and Deeds of Trust
These two documents serve basically the same function; whether one or the other is used is basically what the customary form is in that area you are doing the sale.
Both a mortgage document and a deed of trust will provide security for the seller. In effect, they place a lien on the property that provides the remedies if a buyer defaults on their payments. The documents are filed at the local courthouse to ensure there’s a legal record of the lien, and expectation of repayment, and provide the basis for foreclosing if necessary. The method of foreclosure is specified (and varies depending on whether a mortgage or deed of trust is used) should the owner need to repossess the property.
Some Complications With Seller Financing Today
Owner financing was a lot more common than it is today. Changes in lending practices related to existing mortgages have closed some doors on the possibility of owner-financed deals and recent legislation known as Dodd-Frank has complicated the owner-financing process.
Seller Financing Options with Existing Loan on the Property
One of the most common questions we are asked – and one of the most difficult situations to wrestle with in an owner-financed deal is if there’s an existing loan on the property.
Once upon a time, many existing mortgages were assumable, meaning a buyer could simply take over the obligation to pay on an existing mortgage. this means they would become the new payer and owner of that loan. This worked exceedingly well with owner-financed deals.
With very few exceptions, those days are behind us, and most mortgages today have what is called a due-on-sale clause which makes them un-assumable because any remaining loan balance is supposed to be paid in full at the time of sale.
There are some ways to go around the due-on-sale clause and still set up an owner-financed deal when the property has an underlying loan. All of these get into the realm of creative financing. It is recommended that you enlist the services of a legal expert to help if you attempt any of these.
Here’s a quick rundown on 5 techniques for putting together owner financing if there’s an existing mortgage present:
1. Buying “Subject To” the Existing Loan
This is kind of similar to assuming a mortgage. However, unlike an assumption, the original lender is still on the note. If the mortgage isn’t paid, they are on the hook. This is why when you sell your house this way you make sure the buyer has the ability and means to pay.
2. Wraparound Mortgage
A wraparound mortgage creates one loan that is big enough to pay on the existing loan plus any additional equity in the property. With a “wrap” mortgage, The buyer’s payments are more than the underlying payment. This ensures the seller’s payment is covered. The difference between the two is the owner’s profit and goes into their pocket. Be aware – buyers can be on the hook if the seller doesn’t pay their underlying loan.
3. All-Inclusive Trust Deed
An all-inclusive trust deed is basically a wraparound mortgage. It’s a legal term used in many states to denote the same process.
4. Lease Option or Lease Purchase
With this approach, you actually lease the property from the seller with an option to buy, This allows the buyer to purchase the house, but at a later date. This allows the seller to control the property and selling price until the buyer can arrange for outside financing. Again, buyers need to be wary in case the seller fails to make their payments while the lease option is in effect.
5. Land Installment Contract
This is, perhaps, the most complicated of all forms of creative financing. With this approach, a contract is set up for the buyer to make stipulated payments for a period of time (5 to 10 years is common). Similar to a lease option, it allows the buyer to control the property and price until other financing can be arranged.
The real caution is that with a “land contract,” the buyer has no vested interest in the title to the real estate. If they default on even one payment, the contract is terminated and the seller gets the property back without any need to foreclose.
The Dodd-Frank Act of 2010 Affects Owner Financing
In the aftermath of the subprime mortgage meltdown of 2008 and all the predatory loans that had been issued prior to 2007, Congress enacted legislation that eventually became known as Dodd-Frank. It was aimed mainly at Wall Street, but politics allowed its scope to also blanket private sellers on Main Street who offer owner financing.
The details are beyond the scope of this article, but for the average seller, with a property or two for sale, the Dodd-Frank is of no real concern. It’s not until a person is attempting to sell 3 or more properties with owner financing that Dodd-Frank applies, and among other expectations, they will need to obtain a mortgage originator’s license. For that reason, a lot of owner financing has disappeared from the market.
Owner financing is a financial arrangement in which buyers make payments directly to the seller rather than acquire a mortgage from a financial institution. Payments are usually in the form of monthly Payments of principal and interest (so have everything escrowed). Sellers benefit by getting monthly payments along with a potentially higher selling price and a quicker sale.
If you are looking for owner financing because you looking for a creative way to finance your real estate purchase, reach out to The Aida Group. We buy houses with financing all the time or sell with financing. If you are looking for our financed deals check out The Property Attic.