Owner Financing: What You Need To Know

What is the best way to buy a property with no down payment? 

I was barely 21 years old, and I knew I would make my fortune in real estate. The problem? I had no money or credit. How would I buy a rental with no resources? That is when I started to learn about owner financing. 

What Is Owner Financing?

Owner financing can mean several different things; however, when it comes to a high-level view, it refers to any time the owner of a house helps the buyer obtain financing. It could be as simple as helping with the note and mortgage, or it could be more complicated, such as a lease option or land contract, which we will discuss later.

How Does Owner Financing Work?

Owner financing all starts with an agreement. I love this part of real estate because it involves negotiating a deal that will benefit everyone. Finding an agreement over owner financing is where real estate investors have a chance to shine since they need to be incredibly creative to structure win-win deals. Doing so is a ton of fun and can make you a lot of money. 

Typical Terms

Owner financing provides a lot of flexibility, which means there are no real defined set of standard terms. What makes this so powerful is you can negotiate anything you want, as long as the other party agrees. For instance, you could do a pretty standard note and mortgage with rates closer to what a bank might charge, or you could get creative by implementing terms such as profit participation, assets exchanges, or zero interest rate loans. Yes, I have seen zero-interest loans as long as the principal payments are what the seller requires to meet their cash flow needs.  

Tax Implications

One significant advantage to selling with an owner carry is the potential tax benefits. Creative CPAs can spread out capital gains over many years, reducing a large tax hit in any one year with the correct deal structure. You should definitely consider such a deal structure, but be sure to run it by your accountant first. 

Why Buy A Property With Owner Financing?

I have been lucky enough to purchase more than a hundred homes with owner financing. I was able to do this because I learned many different ways to structure deals and practiced negotiating them. Since I had no cash or credit, I had to learn how to buy houses without a down payment or a bank if I was going to succeed. That being said, there are several reasons you may want to consider using owner financing to purchase an investment property. 

Lower Closing Costs

Because there is no bank involved, there are no bank fees. Lender fees are hands down the most expensive part of buying a house. You will save money on origination fees, administration fees, credit report fees, recording fees, appraisal fees, and possibly even more! With owner financing, a realtor is often unnecessary, which means the seller can save a ton on realtor fees as well. 

Faster Closing Process

Have you ever seen those advertisements from real estate investors that promise to close in seven days or less? How do you think they can do that without hard money or cash? Simple: many of these investors negotiate owner financing deals. When you don’t have a lender or bank involved, you won’t have to wait for an appraisal, loan processing, or loan approval. You are already approved and ready to close, and you can close when the seller is ready.

Flexible Down Payment

All the terms on an owner financing deal are negotiable, including the down payment. I have never put money down on an owner finance deal that I have purchased. It’s not that hard to negotiate for a no-money-down deal; just don’t offer it. On the rare occasion that a seller asked me for a down payment, I would respond, “If I were forced to put a down payment on every house I purchased, I would have no money left in the bank set aside for emergencies. You wouldn’t want that would you?” I would follow up that question with, “If you need a down payment to be comfortable working together, I would understand; but it would not be the best fit for me. Is there something else we can do to make you comfortable?”

 With this said, a down payment is perfectly acceptable if you want to pay one. You do not have to draw a hard line as I have done. 

An Easier Financing Alternative

Because you’re not asking a bank for money, your financial background won’t be put under a microscope. You may not even be asked for your credit report, income documents, or any personal information. As a result, owner financing is the ideal buying strategy for real estate investors who may have trouble getting a loan at the bank.

Why Sell A Property With Owner Financing?

By offering terms on your property, you increase its value. It is that simple. Think about it: if you can offer your home to both buyers who qualify for bank financing and those who do not, you significantly increase the number of possible buyers. That adds value! There are other reasons you may want to offer owner financing when selling property as well. 

Quicker Selling Time

Increasing your buyer pool will also speed up the time it will take to sell. Much like when you buy a home with owner financing, if your buyer is not getting a bank loan, they will not need to go through the lengthy bank process. 

A Better Investment

When you sell a home with owner financing, you are essentially investing in a loan to your buyer. Providing a loan can be more profitable than other types of investments, and when done right, they can be a lot safer. Of course, this depends on what you were initially planning to do with your money and the rate you would charge. For example, you’d earn more with a 7 to 8 percent rate on a note to your buyer than you would earn on interest if you were to put your money in the bank.

Reduces The Tax Burden

As mentioned above, you can potentially differ some of your tax liability by structuring a deal to take your gains over time. Reducing your tax burden in such a way is something you should speak to your CPA about. 

Types Of Financing

The following are the three most common types of owner financing:

Mortgages

A mortgage is when the seller carries a loan for the buyer. For example, if you are the buyer, you would sign a note promising to pay the money back. That note would spell out the deal’s terms, including things like the interest rate, when the money is to be paid (such as in monthly payments), and any maturity dates (which is the date when all of the money is due). 

The buyer will sign a deed of trust or a mortgage to secure the note with the property. As a result, the lender can foreclose and take the property back if the buyer defaults on the loan. The document used will depend on the state, but a mortgage is universally known, so it is the term of choice.

It is important to note that there are several different ways to do a mortgage. If the property is owned free and clear, meaning no underlying loan exists, it is simple. If there is a loan in place, the seller will most likely want to pay that loan off before transferring the title. In those cases, the buyer can bring in their own loan to pay off the existing loan, and the seller can do a mortgage for the balance.  

For example, if an owner is selling for $200,000 but still owes $100,000 on the home, they can carry a loan for any amount over $100,000 for their equity and have the buyer pay off the existing loan balance. Or they could bring in cash or a new loan to pay off the existing loan. If the buyer uses a new bank loan, the bank will want a mortgage, which means that the seller’s initial loan would be considered the second mortgage. A second mortgage is a subordinate position. In that case, if there is a default, the second mortgage holder would need to pay off the first mortgage to get the property. Such a situation can get a little confusing, but just know that the owner can carry all of the purchase or a portion of the loan. If they carry a portion, the balance of the purchase can be in cash or another loan. 

Pros For Buyers

The pros for purchasing a home this way are many. First, as we have discussed, you can qualify for this type of financing even if you can’t obtain financing from a bank. As a result, you can build an extensive portfolio of properties without anyone telling you that you can’t do it. You can also negotiate better terms, save money on fees, keep the debt off your credit report, and close quickly.

Pros For Sellers

By offering an easier way to purchase your home, it will increase its value. You will also put yourself into a secured investment and can get your house sold fast!

Land Contracts

A land contract, also known as a contract for deed, is a bit more complicated. With this arrangement, the buyer will have most of the rights as the owner but won’t be on title. They won’t get the deed to the house until the contract is satisfied and paid in full. Think of buying a car using a loan. Technically, you’ll own it, which means you can use, sell, rent, or lend the car. However, you won’t have the physical title. The title stays with the lender until you pay for it. A land contract operates in the exact same fashion. 

When buying with a land contract you will sign and record the contract giving you the rights of a normal owner, like selling the home or renting it out. These agreements are often used on homes with debt currently in place that will not be paid off when it sells. Typically, a land contract will state that you will make regular monthly payments to the owner or directly to the underlying lender for a set period. At the end of that period, you will need to pay the entire balance of the amount owed on the home. These agreements can be very effective and are popular in certain parts of the country.

Pros For Buyers

Purchasers enjoy Many of the same benefits as with the mortgage. You will have full use of the home and even get all the tax benefits of owning it with no banks to worry about. 

Pros For Sellers

Again, many of the same benefits apply to sellers, but a land contract allows you to carry a loan for your buyer even if you have a loan on your home that you are not paying off. The downside to this for a seller is a longer foreclosure timeline, so I would suggest speaking to an attorney before moving forward with this. 

Lease-Purchase Agreements (Rent To Buy)

I love the rent-to-buy strategy. I love it because it is easy to understand, and sellers and buyers can get it. The arrangement is an agreement for the owner to rent the home to a tenant for a set monthly rate. The tenant then has the option to buy it in the future. It is an effective strategy that benefits both buyers and sellers.

Pros For Buyers

I got my start using lease-purchase agreements, and it let me buy a house or two a month while in school with no cash or credit. It is a simple way to negotiate deals with sellers with no down payment. It is also a great way to protect yourself because you have the option to buy, not the obligation, so if the market crashes, you can get out. 

Pros For Sellers

A lease-purchase agreement works better when renting homes instead of selling them. In my experience, less than 5% of the tenants who have agreed to a lease-purchase agreement will buy. If they do, great! You will make money by charging a premium on the home and collecting rent. If they don’t, also great. You had a tenant that thought they were going to buy, lived there for a handful of years paying rent and taking care of your property, and now you can do it again. 

Things To Be Aware Of

Although owner financing is a fantastic strategy, there are risks.

Buyer Risks

Because you can negotiate for anything you want, you might find sellers asking for higher interest rates than you would pay for a bank loan. They also might like other terms that do not benefit you, like, shorter payback periods or larger down payments. If you agree to terms that you cannot meet, like a maturity date, you could lose the house through a foreclosure. It is also more challenging to find sellers to agree to terms like this than it is just to offer to buy the home outright with your own loan.

Seller Risks

The risk of owner financing is far greater for the seller. Because your buyer owns the home, you cannot evict them if they stop paying you like you can with a renter. You will be forced to go through a foreclosure process, which can be slow and costly. If you do need to foreclose, you could end up with a property that is in poor condition and needs repairs. Additionally, you won’t get all of your money at the time of the sale. Although there are a few advantages to this, there is one potentially major disadvantage: you could find yourself needing the money at some point in the near future (such as if you need to buy a replacement property).

Is Owner Financing Right For You?

Owner financing is another tool in the real estate investor’s tool belt. While not a perfect fit in every situation, every investor can benefit from understanding it. Begin by educating yourself on your options and then working with other investors or advisers that understand the ins and outs of owner financing. We are real estate investor financing experts. We are more than happy to go through your specific deal and discuss possible financing options.