The Basics Of Owner Financing

How does owner financing work? It’s a simple question, but nonetheless important to ask. After all, those familiar with the concept of an owner financed mortgage are presumably awarded an inherent advantage. At the very least, the more financing options one has at their disposal, the better. That said, now may be the perfect time for you to brush up on the intricacies of owner financing, or perhaps even add another tool to your investor arsenal.

What Is Owner Financing?

Owner financing witnesses the owner of a property step into the role of a traditional lender. In its simplest form, however, owner financing is exactly what you’d expect: the individual responsible for selling the property will simultaneously act as the bank for the respective buyer. Often referred to as “creative financing” or “seller financing,” owner financing awards prospective buyers the opportunity to sidestep traditional financial institutions and seek financing from the individual actually selling the home.

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How Does Owner Financing Work?

In order for owner financing to work, there are a few important criteria that must be met for things to move forward. First and foremost, the owner of the subject property must own it free and clear; they must be in an equity position no less than 100 percent. Additionally, the two parties must agree to terms. More often than not, the latter poses more of a threat to facilitating an owner financed deal because most sellers aren’t even familiar with the concept. Therefore, in addition to the owner maintaining a 100 percent equity position on the home, they’ll need to be convinced that owner financing is right for their particular situation.

Once the initial criteria are met, owner financed mortgages are rather simple to comprehend. In their simplest form, owner financed mortgages operate a lot like their traditional counterparts, but with one significant caveat: instead of the borrower making payments to a bank, they make payments directly to the seller. The buyer will make monthly mortgage payments to the seller based on the predetermined terms outlined in the owner financing agreement. The buyer will typically sign a promissory note to the seller with information on the interest rate, repayment schedule and consequences for defaulting.

The Benefits Of Owner Financing

Both buyers and sellers are made privy to the benefits of owner financing. Here’s a breakdown of what each side could hope to realize in the event they successfully initiate an owner financed deal:

The Buyer

Not surprisingly, the most attractive advantages of owner financed mortgages are awarded to buyers; that’s because the terms are almost entirely negotiable. That said, in order for a buyer to truly benefit from owner financing they must develop an inherent familiarity with the negotiation process. With at least some degree of negotiation experience, there’s no reason a buyer couldn’t at least try to negotiate favorable terms.

Additionally, owner financing contributes to the myriad of financing options already made available to today’s buyers. With an additional means of acquisition, buyers increase their odds of securing funding. Subsequently, buyers won’t have to jump through the same hoops banks typically require borrowers to navigate.

The Seller

Owner financed mortgage options award sellers one particularly encouraging benefit: flexibility. It is worth noting, however, that the primary beneficiary of the resulting flexibility isn’t the seller, but rather the buyer. Owner financed mortgages award buyers the flexibility to choose from more financing options. Therein lies the true benefit for sellers: they win when it’s easier for potential buyers to facilitate a deal. The mere option of owner financing awards buyers one more way to facilitate a transaction, which bodes incredibly well for sellers. A seller’s priority is, after all, to sell a home, and owner financed mortgages give them one more way to do so. As a result, owner financed mortgages have served as a vehicle to attract more buyers.

Perhaps even more importantly, sellers comfortable following through with owner financing may be in line to receive a much larger down payment than their traditional banking counterparts. Due, in large part, to the risk owners typically assume, it’s not unreasonable for them to demand a down payment upwards of 20 percent or more.

Typical Owner Financing Terms

Thanks, in large part, to the removal of banks from the equation, the terms of most seller financed deals are not constrained by the same “red tape” traditional real estate deals have become synonymous with. To that end, each party involved in an owner financed transaction is free to suggest terms. Since there are no strict guidelines to adhere to, borrowers and lenders are free to exercise any options they see fit. It is important to note, however, that the terms will need to be fair for the other party to accept them. That said, common owner financed terms will often include the following:

• Variable Down Payments: More often than not, sellers will request larger than average down payments in order to compensate for the added risk. However, it’s not uncommon for the down payment on owner financed mortgages to vary dramatically, oftentimes between five and 25 percent.
• ”Shorter” Loan Amortization Periods: While traditional banks are ubiquitous with 30-year loans, home owner financing doesn’t welcome as much patience on the owners behalf. Therefore, loan terms will usually rest somewhere in the neighborhood of 15 to 20 years, wrapped up earlier with a balloon payment if the terms deem as much.
• Balloon Payment: Most sellers will require a balloon payment before the loan is paid of completely. When the payment is made over the course of the loan will differ, but it’s quite common for lenders to request at least one sizable payment.
• Interest Rate: Again, like everything else we have discussed up to this point, the interest rate will be negotiable. However, it’s not fair to expect one party to cave to demands. As a result, most interest rates on owner financed mortgages are relatively honest. More specifically, it’s pretty common to see interest rates in the seven to eight percent range.
• Promissory Notes: Most lenders (homeowners) will require their borrowers to sign promissory notes. As their names suggest, promissory notes represent a borrower’s intent to pay back the loan, and disclose any penalties that may be incurred if the terms are not fulfilled. Due to the sensitive nature of promissory notes, sellers will typically enlist the services of legal professionals to secure their loan.

Summary

How does owner financing work? The answer is more simple than most people realize: a lot like a traditional loan. Instead of borrowing from a bank, however, the buyer will actually borrow money from the individual selling the home. To that end, owner financing can benefit each party when terms are implemented carefully. With a little due diligence, there’s no reason both sides of a transaction can’t walk away incredibly happy, but I digress; the only way that’s going to happen is if you know how owner financing works.

Key Takeaways

• How does owner financing work? The answer is simple: instead of borrowing from the bank, a buyer will actually borrow from the individual selling the house.
• Typical owner financing terms are varied, and contingent on the parties drawing the terms in the first place.
• An owner financed mortgage will witness the seller loan the purchase price to the buyer, in return for installment payments over a prolonged period of time.