What to Know About Owner Financing
Buying a home often involves getting a mortgage to finance the home purchase. But if you can’t qualify with a traditional lender, you may have another option: owner financing. In this scenario, a homebuyer gets a loan directly from the home seller, rather than jumping through the usual hoops of applying for a mortgage through a lender. The seller can gain income from the loan interest, but in turn, they’re taking on risk and responsibility.
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What is owner financing?
In owner financing, also known as seller financing, the owner and buyer agree on the purchase terms. After both parties sign the paperwork, the buyer can move into the house and take possession of the property.
Each month, the buyer makes a payment to the owner. Note that property taxes and homeowners insurance aren’t often included in the monthly payment for owner financing — the buyer must make those payments separately.
Things you should know
Owner financing tends to take the form of a balloon loan, which is generally a five- to 10-year contract. The buyer makes a single large payment at the end of the loan term, called a balloon payment, to completely pay off the loan. The buyer can pay it in cash or refinance the home and make regular monthly payments to a conventional lender.
What about partial owner financing?
The owner can provide partial financing to the buyer. For example, if you want to buy a $300,000 home and the lender will only provide $250,000, you could get owner financing for the remaining $50,000 as a second mortgage with lender approval.
What’s included in an owner financing contract?
Owner financing can take the form of a promissory note, deed of trust or rent-to-own contract. Whatever structure the contract has, here are items that must be included:
- Purchase price, down payment and loan amount
- Interest rate, loan term and amortization schedule
- Monthly payment and balloon payment details
- Penalties for late payments and default
Example of owner financing
Imagine you find a farm out in the countryside for $250,000, and it doesn’t qualify for a conventional mortgage due to the age and condition of some of the buildings on the property.
You offer to purchase it for the full price with a 20% down payment ($50,000). The seller agrees to finance the remaining $200,000 at a 7% interest rate for a 10-year term, amortized over 20 years. Your monthly payments would be $1,551, plus tax and insurance payments, and at the end of 10 years, your balloon payment would be $135,098.
You can use an online mortgage balloon calculator to run some numbers of your own.
Pros and cons of owner financing for buyers
| Pros | Cons |
|---|---|
Less strict credit and property requirements. The owner may not require you to have good credit and the property doesn’t have to be in great shape. Lower closing costs. You don’t have to cover bank fees and potentially don’t have to pay appraisal or inspection fees. Faster closing. The closing process can be much quicker, due to shortened due diligence. | Higher interest rate. Owner financers typically charge a higher interest rate than conventional lenders. Less availability. Not all sellers are willing or able to offer owner financing. Large down payment. Many deals require a 20% down payment. Balloon payment. Many deals involve a balloon payment, which can be hard to save up for, and there’s no guarantee you’ll be able to refinance with another lender. |
Pros and cons of owner financing for sellers
| Pros | Cons |
|---|---|
Few property requirements. You can sell the home as is — you don’t need to meet a lender’s appraisal requirements. Faster closing. With fewer due diligence requirements, you can complete the sale quickly. Positive investment return. In providing the loan, you receive the down payment and the monthly payment, with interest. Investment adaptability. Depending on state law, you could sell the loan to an investor, or if the buyer defaults, you could retain the money you've received, plus regain the property. Tax advantages. You could spread any capital gains taxes over multiple tax periods. | More work. You’ll need to check the buyer’s credit report, confirm their income and more. More risk. The buyer could default on the loan and damage the home, forcing you to initiate the foreclosure process and pay for any repairs. Laws can be complex. Federal and state law can limit owner financing contracts and balloon loans as a matter of consumer financial protection. Ownership required. If you’re selling your home in an owner financing deal, you first need to pay off your own mortgage and have the title in hand. |
Is owner financing a good idea?
It can be a good idea when both parties are confident that the buyer is able to make all the payments, including the balloon payment. Both should also have a real estate attorney and potentially a tax accountant review the paperwork before signing.
| The seller should … | The buyer should … |
|---|---|
Perform a background and credit check Confirm employment and income Require a down payment | Get a home inspection Pay for title insurance Consider ordering an appraisal |
Frequently asked questions
What if the buyer can’t make the balloon payment?
If the homebuyer can’t make it in cash, conventional financing is the next option. Otherwise, a home sale may be the best bet if the buyer or property doesn’t qualify for financing. Offer it back to the former owner, or put it on the market. The house should be sold for market value and will hopefully more than cover what’s owed.
Where can I find owner financing?
Owner financing is more common in a buyer’s market, and sellers who offer it typically advertise it in the listing for the house. Owner financing is also more common when the buyer and seller have an existing relationship as relatives or friends.
What if the buyer defaults?
If a buyer defaults on a rent-to-own contract, the seller can initiate eviction proceedings. If they default on an installment loan, the seller can start foreclosure proceedings. State requirements vary for both situations.
Are there other names for owner financing?
Owner financing can also be called:
- Seller financing
- Purchase-money mortgage
- Creative financing
- Bond for title