Owner financing or seller financing refers to an arrangement where the seller or property owner offers to finance the buyer. The seller credits the buyer enough money to cover the price of the home, excluding the down payments. Thereafter, instead of the buyer deposition money to the lender on a monthly basis, the buyer makes regular deposits to the seller until the loan is fully paid. The buyer must sign a promissory note, which lays out the details of the purchase agreement. The owner then retains ownership to the property until the buyer completes all the payments.
Such agreements often go for a short time. In reality, sellers will refrain from an agreement that ties them to the property or buyer for decades. Ideally, such agreements contain a 30-year amortization period, which includes a lump sum repayment or a balloon payment of the outstanding principle, payable in five years.
The agreement operates in the hope that the buyer will have enough equity after five years, as a result of increase in value of the property to pay the remaining amount. It also hopes that the buyers improve their financial standing, which increases their chances of accessing financing from traditional lenders.
Pros of Owner Financing
As a buyer, you do not need approval to start your journey to home ownership. If you fail to meet conventional lending requirements, you may not qualify for home loan. Owner financing gives you the financing assistance you need to buy a home immediately. It also does not rely on underwriters and reviews from lenders. You can access the financing immediately without having to wait for the lengthy documentation processes involved in traditional lending.
Owner financing is more cost effective for the buyer. It eliminates administrative, appraisal and other hidden charges you might incur with traditional lenders. Owner financing is often direct; the only cost you incur is the amount you pay for the house and the interest as per your agreement with the seller. It further offers a more flexible payment plan, there is no minimum down payment requirement. Traditional mortgages require a down payment of 5 percent, with Private Mortgage Insurance (PMI) for any down payment below 20 percent.
As a seller, owner financing helps you close quickly: you do not have to wait for the buyer to secure financing to seal the deal. You can also hold on to the title until the buyer completes payment. Once you begin the process, the house is technically yours. If the buyer defaults, you can keep the deposit and re-sell the property to a willing buyer. Additionally, once the buyer signs the promissory note, you can sell it off to an external investor, which gives you a lump-sum amount instead of waiting for the buyer to repay the mortgage in installments.
Cons of Owner Financing
While buying, the convenience of avoiding a traditional lender may mean that you have to pay a higher interest. In the end, you may have to pay more for the house when compared to traditional lending. Additionally, you still need approval on the part of the seller to access owner financing. However, the process is shorter and faster than traditional lending. The balloon payment, due after five years, may also disadvantage you if you cannot raise it in the stipulated time. You may risk losing the home.
Your purchase is further dependent on the seller, who must approve the agreement. Ideally, the lender must provide proof of ownership for the property without any pending mortgage payments. If this is not the case, the seller must convince the lender to accept owner financing. Additionally, the lender might demand immediate payment on any outstanding debts, specifically when the home is on sale as a result of a 'Due on Sale', which legally permits the lender to foreclose on the home if full mortgage payments are not made.
As a seller, there is no way for you to guarantee that the buyer will keep up the payments as agreed. If the buyer defaults, you risk going through foreclosure. You must also provide a clear and free title, which means that you must go through your lender if you have an outstanding mortgage. This may prolong the process or stop you from selling.
Whether you are acting as the buyer or seller, consult a property attorney with experience in such matters, and a financial adviser to help you identify any potential taxes that may affect owner financing. If you are the buyer, consult a financial adviser to guide you in building your credit score and help you secure traditional financing within five years. For sellers, insist on a hefty down payment and run a credit check on the buyer to ensure the loan is secure.
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