Requesting a seller to offer owner financing when you need to purchase a home is a very difficult proposition. The listing agent may have no idea if the owner intends to partly or fully take care of the financing. Sellers often turn down seller financing propositions because they are unaware of how beneficial the arrangement can be. Some sellers are not even aware that owner financing exists. Do not blame them because they do not sell property every day. In all likelihood, their knowledge does not go beyond conventional real estate practices where buyers obtain mortgages from banks.
Seller financing is ideal in buyers’ markets, when homes are not selling. It is also suitable in situations where lender guidelines are very tight.
What is owner financing?
It is an arrangement whereby the mortgage process is handled by the seller, not a financial institution. The buyer enters into a mortgage agreement with the seller, rather than apply for a normal bank mortgage. Other terms used to describe this type of arrangement are purchase money mortgages and seller financing.
Tautness of the credit market determines the number of people who opt for owner financing. In situations whereby financial institutions are unwilling to take risks and hesitant to lend money to clients who are considered credit-unworthy, such clients can make use of this form of financing to purchase homes. Additionally, owner financing can make it easier for home sellers to dispose their property
On the other hand, when the credit market loosens up and financial institutions are more eager to lend money, owner financing becomes less appealing. Balloon payment is among the most important components of this form of financing, and it is usually made several years later.
How does it work?
Just as the word suggests, the person disposing property lends money to the buyer to enable purchase of a property, instead of the former acquiring a home using mortgage from the bank.
A promissory note is executed by both parties (seller and buyer), and the negotiable instrument prescribes the rate of interest, consequences of default as well as repayment schedule.
The seller receives monthly mortgage payments from the buyer. The former earns an interest rate that is usually high. If the seller opts to sell the loan facility, any investor who buys it will start receiving monthly mortgage payments.
In most cases, owner financing arrangements have a short lifespan, and the buyer is often required to make a balloon payment at the tail end. The buyer is generally expected to refinance before end of the prescribed repayment period.
This form of financing arrangements can easily backfire, so all the involved parties must tread carefully.
Owner financing is common in financial markets where obtaining mortgage facilities is difficult. That is because when credit is very tight, selling homes becomes difficult, so sellers are forced to consider other options.
In addition to that, when a potential buyer cannot obtain a mortgage yet they are readily available, the seller doubts the buyer’s capacity to pay. Therefore, when buyers have difficulty obtain loans, most probably there are well qualified potential buyers who are unable to secure traditional financing.
Why sellers offer financing
The following are reasons why home sellers often opt to offer financing:
- To reduce the costs of carrying while eagerly waiting to get a perfect buyer and quickly strike a deal.
- To get rid of expenses that home owners have to offset every month.
- To make the property appear different or even better than other listings, and therefore dispose it faster, especially in buyers’ market.
- To offset down debt.
- To increase the likelihood of collecting the property’s full asking price.
- To obtain a down payment that can help acquire another property.
Buyers who are unwilling or unable to obtain traditional financing are not the only beneficiaries of seller financing arrangements. Sellers who are eager to sell their property also get immense benefits.
How to make it happen
If owner financing seems appealing to you, how do you go about it?
- Add to the property listing
As a seller, you can indicate availability of the financing offer in a property listing. Adding the words owner financing available can make agents and potential buyers aware of the deal.
- Avail the information
When potential clients come around for viewing, give out information that describe terms and conditions of the offer. Many potential buyers do not know what owner financing is all about, so describing what it is can be a brilliant idea.
- Request the seller to give owner financing
If you are a buyer looking for this form of financing, you can request sellers for it. The secret is to have it presented in a correct manner. Instead of inquiring if it is an option, simply present a definite option.
For instance, you can offer full price with twenty percent down payment, owner financing for 350,000 US dollars at a rate of 6%, amortized over a period of 30 years, and a 5-year balloon. Offer to enhance the rate by 2% in the fourth and fifth year in case of failure to refinance after three years.
- Make the other party relax
The image that you portray should make the property seller comfortable with the financing arrangement. Naturally, the seller will seek to find out why you claim to be credit-worthy, yet you were incapable of obtaining a mortgage elsewhere. For instance, you can explain that the business is still new, so you cannot obtain a loan for 24 months, even though you have an attractive credit profile and can make a reasonable down payment.
Similarly, a seller must make potential buyers comfortable by painting a good picture. The seller should clearly explain what owner financing is, why buyers should consider the option and why it works.
Since the arrangement is not as common as other types of financing, it is important for all parties (sellers and buyers) to seek guidance from lawyers and finance experts who understand how ownership financing works. That should be done at the beginning. The experts are expected to safeguard the best interests of their clients and offer guidance throughout the process.
Types of owner financing
All inclusive mortgage
this is a common arrangement whereby the promissory note as well as mortgage for the whole balance of price of the property is carried by the seller, less down payment made. It is also known as AITD (all-inclusive trust-deed).
most lenders are hesitant to provide anything that exceeds 80% of the value of a property. To fill the gap, sellers can extend credit facilities to buyers. In that regard, they can carry a junior mortgage for the purchase price balance, less the down payment (if any).
this is a financing arrangement whereby a buyer is allowed to take the place of a seller on an existing mortgage. Most FHA, ARM and VA loans can be assumed with the approval of banks.
it is a unique type of seller financing whereby the title is not passed on to the buyer. Instead, the buyer gets equitable title to the property, which means ownership that is temporarily shared. The seller keeps receiving regular payments from the buyer and only transfers the title upon completion of payment.
this is an arrangement whereby a seller leases property to a willing buyer for a period of time agreed upon by both parties, just like a traditional rental arrangement. However, the seller agrees to sell the real estate property within a specified period of time in the future, in exchange for a fee that is paid up front, at terms and conditions agreed upon by both parties.
Advantages of owner financing for buyers
This form of financing offers buyers several benefits:
Fast closing process
Careful sellers and buyers usually perform due diligence by looking at the closing period. However, the closing process is faster with seller financing. That is because parties are not forced to wait for clearance of the file by loan officers who work in banks, legal departments as well as underwriters. The conventional clearance process can stretch up to three months.
Flexible amount of down payment
Down payment can be any amount of money agreed upon by buyer and seller, rather than having to raise the minimum amount prescribed by the government or financial institution. A seller may not necessarily accept payment lower than what would be required in a bank or elsewhere. However, the possibility is always there.
Lower closing costs
Most buyers opt for seller financing since the arrangement allows them to move into property for less money. Buyers are not forced to pay appraisal costs and hefty bank fees.
Disadvantages for buyers
- The rates of interest charged by sellers are usually higher than what financial institutions charge. Buyers are compelled to pay interest at rates that convince sellers to lend money rather than invest it elsewhere
- Promissory note can be sold by the original seller. Even though it is inconsequential, it means the buyer will have to make payments to a new party.
- Buyers must still provide proof of their credit-worthiness. It is one issue if two parties (buyer and seller) only wish to remove the financial institution from the whole equation. However, if the buyer is willing but unable to secure a traditional mortgage, there may be valid reasons for that. Since the bank did not want to risk lending money to the buyer, a prudent seller cannot make that mistake.
- Buyer must ensure that the property is owned by the seller and has no encumbrances, or the seller’s bank has no objection to the transaction. Most mortgages have a clear due on sale section that prohibits sale of the property without first paying the mortgage. If a mortgage company discovers that a seller has executed owner financing, the company will assume that the property has been sold. Therefore, it will demand immediate and full payment of the outstanding debt, which gives room for foreclosure by the lender.
Advantages of owner financing for sellers
- Shorter listing term- the arrangement attracts the attention of a different set of potential buyers. Seller financing can make a home stand out from thousands of other houses, especially if normal methods fail to attract the attention of buyers.
- Higher sales price- since the seller offers the arrangement; he or she is more likely to command a full listing price.
- Higher interest rate- the type of financing can carry a rate of interest higher than what sellers might get in a normal money market or other types of investments associated with lower risks.
- Tax breaks- owner financing is beneficial since sellers may pay less amounts of tax on installment sales and only report the annual income received.
- Monthly income- the seller’s cash flow increases due to payments received from the buyer, thus boosting the seller’s spendable income.
Documents required for seller financing
An ownership financing arrangement can only take off if the following documents are availed:
- Sale & purchase agreement that spells out the closing date, acceptable inspection & clear title report as well as other requirements that must be met, the name of title insurance company, details concerning down payment and final sale price.
- The promissory note that contains important information such as the name of the buyer, consequences of defaulting, the address of the property, terms for missed payments, amount of loan, repayment schedule and rate of interest.
Definition of terms
The following are terms that are commonly used in ownership financing arrangements:
this is a common term that refers to any person who offers a home mortgage loan, takes a home mortgage loan or negotiates terms and conditions of a home mortgage loan, for gain or compensation either directly or indirectly, or while expecting gain or compensation either directly or indirectly.
it refers to a large payment that a buyer is expected to make at the end of a seller financing loan. Only a fraction of the principal is amortized over the agreed period of time.
down payment is a common term that refers to cash payment made at the beginning of the purchase. It represents a fraction of the whole purchase price and may not be refundable.
this is a loan that comprises of interest as well as the principal amount. It must be repaid periodically. Payment offsets the applicable interest expense before payment and reduction of interest.
it is a common term that refers to value of a property or other types of assets less liabilities.
it refers to a legal process whereby a lender forecloses/ cancels right of redemption of a borrower of a property through an order issued by a court of law. The judge sets a date when the property can be redeemed by offsetting the whole loan balance as well as the expenses of foreclosing.
it is an order that can be executed upon the sale or transfer of ownership of a particular asset.
There are various ways of purchasing and selling houses. You can buy that dream house, even if your financial situation is not as good as what many conventional lenders prefer.
Conversely, you can sell your house within a few weeks even if financial institutions use stringent measures to approve borrowers. If you have been looking for a good financing arrangement to acquire or sell real estate property, consider owner financing. You will not be disappointed.