When both parties are on the same page, an owner-financed home purchase can work out beautifully.
The main reason a potential home buyer may look for an owner-financed property is they are unable to secure loan approval from a traditional mortgage lender. That's not to say anything terrible has happened. Yes, their credit score may need a boost, but it's also possible they haven't had time to build a credit history. Maybe they just graduated college and haven't taken on enough debt to build their credit history, or maybe they're new to the country and are starting over.
Whatever the reason, an owner-financed property can be a good option. However, whether you're the buyer or the seller, it's vital that your contract protects you and your financial interest. Fortunately, there's no boilerplate contract you're forced to use. When you enter an owner-financed home sale, both parties have a say as to what's included.
First things first
No matter what your contract ends up looking like, it's paramount you adhere to your state laws and regulations. While you can find a blank owner-finance contract online, that contract won't outline what your state requires of you to make it legally binding.
Ask an expert
The safest, easiest way to ensure your contract is legally binding is to hire an experienced real estate attorney. Nationally, this cost ranges from $150 to $350 per hour. Unless there are significant problems with the contract you've drawn up, it's highly unlikely it will take an attorney longer than one hour to review it and make suggestions.
This step is important for both buyer and seller. Let's say a seller pays an attorney to look over the contract. That attorney is working on behalf of the seller, making sure the deal is fair for them. Buyers also need to hire an attorney to work on their behalf.
Does anyone want to spend the extra money on an attorney? Unlikely. However, not doing so can end up costing you far more if things go south.
More: Check out our picks for the best mortgage lenders
Contract essentials
The first set of details included are fairly basic.
1. Agreed-upon sales price: This is the amount the buyer and seller agree is fair. If the buyer wants to ensure they're not overpaying, now is the time to hire a home appraiser to learn the true value of the property.
2. Amount of the non-refundable deposit: Like most traditional mortgages, owner-financed homes typically include a down payment.
3. Remaining loan balance: This is how much the buyer will need to repay before the home is theirs.
4. Agreed-upon interest rate: The interest rate associated with an owner-financed home is normally a bit higher than the interest rate charged by lenders. However, there are two reasons a seller may not want to hike that rate too much. First, they'll have access to tax breaks associated with owner-financing. Second, they don't want to put the buyer in the position of being house poor. A house-poor buyer is more likely to miss payments, a problem that opens a whole new can of worms.
5. Fees associated with the loan: If the buyer agrees to it, the seller can add in fees for things like the home appraisal or the cost of hiring an attorney. Again, there's no reason to get greedy here. Ideally, buyers can move in with enough money left in their bank accounts to cover emergency situations.
6. Amortization schedule: To give the buyer a clear picture of how much they will end up owing at a specific point in the future, a seller should include an amortization schedule. This indicates how much of each payment will go toward principal and to interest. It also allows them to see how much they'll owe when it's time to refinance (more on that in a moment). Sites like Calculator.net allow sellers to easily create a schedule.
Monthly obligations
An excellent contract outlines what is expected of both the buyer and the seller. For example:
7. Total monthly payment: The contract should clearly state how much the monthly payments will be, including principal, interest, taxes, and insurance.
8. Due date: The date payment is due each month.
9. Grace period: If the seller is offering a five- or 10-day grace period before a late charge is assessed, that fact should also be included in the contract.
10. Payment address: Where the seller wants the buyer to mail the payment each month. If the seller would prefer to have it deposited into a specific bank account, that account number should be listed instead.
11. Late charges: How much the seller will charge the buyer if a payment is late.
12. When the loan is due: Owner-finance deals vary, but one typical scenario involves giving the seller five years to pay the owner before a balloon payment is due. Let's say there's $200,000 left on the loan as the two parties approach the five-year mark. The home buyer would be responsible for refinancing the property through a traditional lender and paying off the existing mortgage. In theory, this gives the buyer time to get their credit score up to snuff.
Thorny issues
13. HOA fees: While the home technically still belongs to the seller until the buyer refinances, the contract should clearly state who is responsible for paying any HOA fees. If it's the buyer, the homeowner should insist on proof that the payment has been made. There are plenty of instances of homes being repossessed by homeowners associations for lack of fee payment.
14. Upkeep: In the event the buyer skips out or the seller must repossess the home, it is vital that the property is in good enough condition for the seller to find a new buyer without pouring thousands of dollars into repairs. Typically, it is the buyer who is responsible for all home maintenance.
15. Repairs: The buyer promises that they'll refinance and purchase the home from the seller at some point in the future. For that reason, contracts normally name the buyer as the party responsible for home repairs.
Thornier issues
16. Remedies: Let's say a buyer fails to keep up with home repairs. The contract should clearly state the seller's potential remedies. For example, it may say the seller has the right to sue the buyer for the cost of repairs plus court fees.
17. Repossession: This portion of the contract covers at what point the buyer can expect the seller to begin foreclosure proceedings and take possession of the property. For example, it may be after three months of missed mortgage payments.
No detail too minor
The best way to avoid miscommunication is to add as much detail to the contract as possible. In fact, there is no detail too minor to include. The goal of the contract is to protect both parties, and the best way to do that is to begin on the same page.
