Owner Financing- Is it Right For You?

Although mortgage interest rates are expected to stay stable for the next few months, the recent rise has left some would-be buyers second guessing as they go through the complicated process of obtaining a loan.

With lending guidelines tightening, the approval process has gone from a quick stop at the bank to a lengthy and time-consuming review of work history, credit and debt-to-income ratio.

Typically, when someone buys a home, they make a down payment and borrow the rest of the money needed for the purchase. Because of the difficulties many buyers are facing, owner financing has become an attractive option.

Owner financing is when the seller of a home finances, or helps to finance, the purchase of the home by the buyer. It is especially appealing for people who have iffy credit scores or low down payments.  

Usually, mortgage lenders and banks give the best interest rates to the people with the highest credit scores because it is an indicator of creditworthiness.  But today, even someone with a high credit score can have trouble obtaining a mortgage.

Also, mortgage lenders will often establish a minimum down payment and if it can’t be met, the deal cannot be completed. These issues are usually not presented when dealing with owner financing, so someone who might not be able to get a mortgage from a traditional lender might have some success if the seller of the home helps finance the purchase.

Owner financing is a great tool if the seller is willing to do it. When done properly, it offers benefits to both the buyer and seller. The buyer and seller agree upon an interest rate, monthly payment amount and term of the loan, and the buyer pays the seller for the seller's equity on an installment basis.

First, there is very little qualifying. Even if the seller demands a credit report on the buyer, the seller's interpretation of buyer qualifications are typically less stringent and more flexible than those imposed by conventional lenders.

Unlike conventional loans, sellers and buyers can choose from a variety of payment options such as interest only, fixed-rate amortization, less-than-interest or a balloon payment. Payments can mix and match. Interest rates can adjust periodically or remain at one rate for the term of the loan.

Down payments are also negotiable. If a seller wants a larger down payment than the buyer possesses, sometimes sellers will let a buyer make periodic lump-sum payments toward a down payment.

Because buyers and sellers aren't waiting on a lender to process the financing, buyers can close faster and get buyer possession earlier over a conventional loan transaction.

There are also tax breaks for the seller who provides the financing. A seller will usually pay less in taxes on an installment sale because they are reporting only the income received in each calendar year.

On the other hand, buyers are sometimes worried by unusual seller requirements such as balloon payments. The seller might structure the repayment of the loan so that for a set time period, the buyer pays interest only. Then after that time period is over, the buyer is expected to make one large final payment of the whole principal. This might not be a big deal if the buyer will have the cash in a few years, but it can be quite risky if the buyer’s financial situation doesn’t change.

When home sales slow down, seller financing always becomes more popular.  Problems occur when desperate sellers, driven by the need to sell immediately, get talked into providing owner financing without really understanding the risks or the process. They frequently bypass some of the steps in the normal home sales process, especially those which protect the seller. If you selling a home, and are considering homeowner financing, make sure you speak with an attorney that specializes in this area. Your realtor will also be able to recommend a specialist to you.