Key takeaways
- Owner financing is an arrangement in which an owner or seller, rather than a bank or mortgage lender, extends financing to a buyer. This can be a viable option for buyers who don't qualify for a traditional mortgage.
- Owner financing agreements can be structured in a number of ways, including as a second mortgage, a rent-to-own contract or a wraparound loan.
- Owner financing tends to benefit the seller more so than the buyer. It's important for both parties to have an attorney establish and review the agreement.
If you have bad credit or a shorter credit history, you might find qualifying for a mortgage difficult or even impossible. One solution could be owner financing, a unique arrangement that allows you to buy a home without needing to qualify for a traditional mortgage. Here’s what to know.
What is owner financing?
Owner financing — also known as creative financing, a purchase money mortgage or seller financing —is an arrangement in which the home seller provides some or all of the financing directly to the buyer. This type of financing is more common in transactions involving family members or parties that know each other.
Types of owner financing
There isn’t just one way to establish an owner financing agreement. Here are some common setups:
- Second mortgage – If the buyer only qualifies for a portion of the funds through a traditional mortgage, the seller could extend a second mortgage for the remaining financing, typically with a higher interest rate, a shorter loan term and a lump-sum balloon payment. “Typically, the seller will not hold that mortgage for longer than five or 10 years,” says Chris McDermott, real estate investor, broker and co-founder of Jax Nurses Buy Houses in Jacksonville, Florida. “After that time, the mortgage commonly comes due in the form of a balloon payment owed by the buyer.”
- Land contract – In a land contract agreement, the buyer pays the seller directly in installments and receives the deed to the property once they’ve paid the purchase price in full.
- Lease-purchase or rent-to-own – In this arrangement, the buyer rents the home with an option to buy at a set price after a certain period of time. The buyer typically needs to make an upfront deposit, which will be forfeited if they ultimately decide not to buy.
- Wraparound mortgage – If a seller still has a mortgage on the home, they could offer a wraparound loan, meaning the buyer’s mortgage “wraps around” theirs. In effect, the buyer makes payments toward the seller’s mortgage. The seller can charge a higher interest rate on the wraparound and pocket the difference.
Example of owner financing
Say a buyer is interested in a home priced at $380,000 and plans to put down $38,000, or 10 percent. Due to credit or financial circ*mstances, the buyer can only qualify for a mortgage up to $300,000. The seller agrees to finance the outstanding $42,000 at a fixed interest rate over a 30-year amortization, with a balloon payment due after five years.
Reasons for owner financing
Owner financing can benefit buyers who aren’t eligible for a mortgage from a lender, or those who only qualify for some of the financing needed for the purchase. It also gives sellers the opportunity to earn income via interest and, if in a buyer’s market, attract more offers. Both parties might also save some money or time by avoiding the costs or process of working with a traditional lender.
Here are some scenarios when owner financing can make sense:
- The buyer’s credit or finances aren’t sufficient to qualify for traditional financing.
- The buyer doesn’t have enough for a down payment.
- The sale price is too high to obtain traditional financing.
- The parties want to close quickly and/or save on closing costs.
- The parties prefer more flexible terms than what traditional lenders offer.
- The transaction involves a unique or as-is property that traditional lenders aren’t willing to finance.
Pros and cons of owner financing
Owner financing offers much more flexibility for both the buyer and seller, but it’s not without risks, particularly for the buyer.
For a buyer, the main advantage is the ability to buy a home without needing to meet credit, down payment or other qualifying criteria.
“The buyer can get a loan they otherwise could not get approved for from a bank, which can be especially beneficial to borrowers who are self-employed or have bad credit,” says Bruce Ailion, a real estate attorney, investor and Realtor with RE/MAX Town & Country in Alpharetta, Georgia.
The upsides for a seller: the ability to earn more from the buyer’s interest payments and to potentially unload the home as-is, without needing to make repairs.
“Additionally, sellers can obtain tax benefits by deferring any realized capital gains over many years, if they qualify,” says McDermott. “Depending on the interest rate they charge, sellers can get a better rate of return on the money they lend than they would get on many other types of investments.”
Pros and cons for buyers
Pros
- Flexible credit and/or down payment requirements
- No need to apply for a mortgage or undergo underwriting
- Faster and less expensive closing
Cons
- Challenging to find a willing seller
- Higher interest rates and/or a balloon payment, depending on agreement
- Responsible for keeping up with homeowners insurance and property tax payments
- No benefit to credit score if seller doesn’t report payments
Pros and cons for sellers
Pros
- Attract more buyers if offers aren’t coming in
- No need to negotiate offers or pay for repairs
- Faster closing
- Earn income from buyer’s interest payments
- Potential to defer capital gains
Cons
- Arrangements can be complex
- Need to vet the buyer yourself
- Lender might restrict owner financing options if seller still has a loan
- Risk of loss if the buyer doesn’t pay or damages the property
Requirements for owner financing
The requirements for an owner financing agreement depend on how it’s structured. In general, the terms of the arrangement should be outlined in a promissory note and include the following:
- Promise to pay
- Purchase price
- Down payment amount if applicable
- Interest rate
- Loan amount and term
- Amortization and monthly repayment schedule
- Balloon payment if applicable
- Consequences if buyer fails to pay or pays late
- Homeowners insurance and property tax details
The buyer and seller should each have an attorney review the agreement to ensure protections on both sides.
Costs of owner financing
A buyer with owner financing might save some money on closing costs, but there will still be expenses to cover. This includes the cost of a title search and title insurance, which protects the buyer in the event the property has one or more liens on it.
The seller doesn’t require a title search or title insurance, but these are important safeguards for the buyer.
The buyer also typically needs to pay for homeowners insurance and property taxes, depending on the agreement. Unlike a traditional mortgage that includes these costs in the monthly loan payment, the buyer needs to take care of these separately.
Tips to buy or sell a home with owner financing
If you can’t get the financing you need from a bank or mortgage lender, an experienced real estate agent can help you find properties for sale with owner financing.
If you’re the seller and don’t already have a buyer lined up, add the owner financing option to your home’s listing description and decide on your non-negotiables.
“Be sure to require a substantial down payment — 15 percent if possible,” says McDermott. “Find out the buyer’s position and exit strategy, and determine what their plan and timeline is. Ultimately, you want to know the buyer will be in the position to pay you off and refinance once your balloon payment is due.”
If you’re on the other end of the transaction as the buyer, it’s crucial to review the agreement with an attorney.
“It’s also a good idea to revisit a seller financing agreement after a few years, especially if interest rates have dropped or your credit score improves — in which case you can refinance with a traditional mortgage and pay off the seller earlier than expected,” says Andrew Swain, co-founder of Sundae, a San Francisco-headquartered residential real estate marketplace for distressed properties.
FAQ
If a buyer fails to repay the owner financing, the recourse for a seller depends on the agreement. In a rent-to-own arrangement, for example, the seller might be able to start the eviction process.
Typically, the seller retains the deed until the buyer pays the owner financing in full.
One of the easier ways to find an owner-financed home is to search online real estate marketplaces dedicated to these types of properties. If you’re searching with a traditional marketplace like Zillow, try looking at homes listed for sale by owner (FSBO). You could also try searching for a real estate agent experienced in these types of deals.
