Should You Consider Owner Financing?

Key Takeaways:


Owner financing has established itself as one of the most valuable tools in a prospective buyer’s skillset. In offering buyers an additional means to an end, owner financing simultaneously increases the odds of buying a home and reduces the risk of finances derailing an impending deal. That said, owner financing isn’t without its flaws, nor is it meant for every situation. As a result, buyers must learn exactly when (and when not) to use this particular acquisition strategy. Understanding the nuances that have become synonymous with owner financing homes is of the utmost importance, and investors can gain a better understanding of the concept below.

What Is Owner Financing?

Owner financing is an alternative way for buyers to fund the purchase of a home that doesn’t include a traditional lender. Instead, the home owner will play the role of the bank and finance the impending purchase themselves. The buyer will then be expected to repay the owner/seller by making monthly payments based on predetermined timeframes, interest rates, and terms. The process isn’t all that different from a traditionally financed mortgage, but instead of repaying an institutional lender, the borrower is making payments directly to the homeowner. To be clear, there’s more nuance to the concept of owner financing, but we will break down exactly how it works in the next section.


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How Does Owner Financing Work?

In its simplest form, owner financing is an agreement between a homeowner and a prospective buyer, which states the owner’s willingness to finance the next buyer’s purchase. It is worth noting, however, that not every homeowner is allowed to conduct their own seller financing. Certain criteria must be met for the owner to pursue this particular strategy: they will need to make sure their current mortgage is paid in full, or they will need to pay off their entire balance before making an agreement with the next buyer. In other words, the home must be owned free and clear for the seller to consider using owner financing.

In the event the home is owned free and clear, buyers and sellers will negotiate several terms: loan amount, monthly payments, who is in charge of maintaining the property, interest rate, loan duration, repayment schedule, default consequences, and anything else either side finds necessary for inclusion. All of the agreed-upon terms will be included in a promissory note which everyone signs. The homeowner will hold onto the promissory note for the duration of the loan’s repayment and will serve as the guideline moving forward.

Once each side has agreed to terms and given their consent by signing a primary note, the rest of the transaction will be carried out like a traditional loan. The borrower will receive financing from the homeowner and make monthly payments until it’s paid in full by the agreed-upon date.

Sellers willing to finance the sale of their own property may forgo a large-sum, immediate payment, but their patience will be rewarded with more profits in the long run. In addition to receiving monthly installments, the seller will capitalize on the agreed-upon interest rate. As a result, the seller will receive the full price of the home, plus interest.

Buyers, on the other hand, will be able to step around any unnecessary institutional involvement. In doing so, borrowers most likely won’t be subjected to strict lending criteria or endless “hoops” to jump through. Owner financing may also enable borrowers with bad credit to receive a loan they would have otherwise been unqualified for.

Owner financing homes

Types Of Owner Financing

Owner financing agreements may be negotiated between buyers and sellers, making them very flexible for everyone involved. While owner financing strategies will be subject to unique laws in each state, buyers and sellers should be able to find something that works for them within their legal rights in most places. At the very least, owner financing can take several forms, not the least of which include:

  • Land Contracts

  • mortgages

  • Lease-Purchase Agreements

Example Of Owner Financing

Let’s say, for example, someone wants to buy a home but lacks the credit score to qualify for a traditional home loan. Typically, the inability to secure a bank loan would suggest the buyer can’t proceed with receiving a loan. However, bank loans aren’t the only way to secure capital to buy a home in today’s market; there’s alternative forms of financing that buyers need to look into.

Of the alternative options, owner financing can simultaneously get the buyer the loan they want and perhaps even better terms over a shorter period of time. Therefore, if the buyer intends to pursue owner financing, they will either need to locate a home that has already announced a willingness to work around traditional banks or persuade the owner to finance the deal.

Once the buyer has found a seller willing to finance a deal, they will need to negotiate terms. At this time each side will give their input and negotiate what they would like to see in an impending deal. Provided each side can come to terms, they will be documented on a promissory note. This note will serve as the “underwriting” for the loan and tell each side how to proceed.

Once the terms are agreed on and signed into existence, the transition will initiate. The seller will finance the purchase of their own home for the buyer. In return, the buyer will make payments to the seller based on the previously discussed terms. The buyer will continue to make payments until the interest and principal are paid in full and the terms of the promissory note are met. Once everything is paid in full, the seller will pass the deed to the buyer, and the transaction will be complete.

Advantages Of Owner Financing

Owner financing has established itself as a popular acquisition strategy in recent years. The ability to finance a home through alternative means opens up buyers to a whole new world of opportunities, like the following:

  • Buyers require little to no pre-qualifications: The inherent lack of an institutional lender rids borrowers of the inconvenience of qualification requirements. That’s not to say the seller won’t have requirements of their own, but rather that they will most likely be less strict. As a result, more buyers will qualify for loans they would have otherwise been passed up on.

  • Financing is entirely negotiable: Again, the lack of an institutional “middleman” leaves a lot of room for negotiation. Most notably, each party may negotiate their own terms, not the least of which will include the sales price, monthly payments, and down payment. However, since financing is negotiable, this benefit can quickly turn into a disadvantage if the negotiations go poorly. Therefore, to benefit from this “advantage,” buyers and sellers must enter into negotiations prepared.

  • Down payments are flexible: Prospective buyers may negotiate down payment terms, which typically work in their favor. Depending on the situation, buyers may want to put down a lot of money upfront, which can save them a lot in interest over the loan term. On the other hand, buyers with little access to cash may also negotiate a lower down payment.

  • Minimal to no closing costs: Since there’s no bank underwriting the loan or facilitating the process, closing costs are going to be significantly smaller than traditional loans.

  • Expedited transition: The transition between the buyer and seller may be expedited without bank interference. In particular, buyers and sellers won’t have to wait the weeks (if not months) it usually takes to receive loan approval. Without a bank overseeing things, the process will most likely move along a lot faster.

  • Tax sheltering: Paring down profits each year by claiming installment payments can reduce one’s taxable income. Instead of receiving one lump sum, receiving 12 smaller payments for several years can lower taxable obligations in a given year.

  • Installment payments for sellers: Installment payments which help sellers mitigate taxes also serve as monthly cash flow, not unlike receiving rental payments. However, instead of only receiving principal payments, each installment includes interest payments. Over time, interest will generate more returns than a traditional sale.

Disadvantages Of Owner Financing

The biggest disadvantages associated with owner financing are directly correlated to the previously discussed advantages. If for nothing else, owner financing is a double edged sword that must be respected. The same flexibility it offers both buyers and sellers can easily swing the other way and work against anyone at a moment’s notice. Anytime two competing sides are negotiating, there’s going to be some give and take. As a result, concessions will need to be made to strike a deal. An inability to negotiate can easily work against buyers and cost them money in the long run.

Summary

The true benefit of owner financing lies in its ability to create opportunities. If, for nothing else, real estate is a numbers game; the more financing options you have at your disposal, the more likely you are to receive the leverage you require. It is as simple as that: those who can secure multiple streams of financing stand a better chance of closing on a deal. That said, owner financing is entirely hands-off; there isn’t a bank to hold your hand through the process. Instead, you’ll need to familiarize yourself with everything above to make sure you do everything necessary to come out on top.


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