Owner financing can mean several different things. However in general, it refers to any time the owner of a house helps the buyer obtain financing. It could be as simple as helping with the mortgage, or it could be more complicated, such as a lease option or land contract.
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. Being creative in structuring an owner financing agreement that is a win-win deal for both the seller and buyer is not only a ton of fun, but it can also generate a lot of money.
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 is incentivized to agree to it.
For instance, you could do a pretty standard note (which refers to the written promise agreeing to the repayment terms) and mortgage with rates closer to what a bank might charge.
Or, you could get creative by implementing terms such as profit participation, asset exchanges, or even zero interest rate loans, which can work as long as the principal payments are what the seller requires to meet their cash flow needs.
One significant advantage to selling with an owner carry (the term used when the owner finances part or all of the sale) is the potential tax benefits. Creative certified public accountants (CPAs) can spread out capital gains over many years with the correct deal structure, reducing the risk of a large tax hit in any one year.
You should definitely consider creating a deal structure like this, 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 started out with 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 don’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 is not 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 like I do.
An Easier Financing Alternative
Additionally, 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 traditional loan at the bank, whether due to poor credit or other factors.
Why Sell A Property With Owner Financing?
By offering terms on your property, you can 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. The following are a few benefits of doing so:
Quicker Selling Time
Increasing your buyer pool will 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 loan process with the banks.
A Better Investment
If you’re the seller and you’re providing owner financing, it means that you’re making an investment in a loan. This is because investing in a loan to the buyer can be more profitable than other types of investments and, when done right, they can be a lot safer too.
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% 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 defer some of your tax liability by structuring a deal to collect your gains over time instead of all at once. Reducing your tax burden in such a way is something you should speak to your CPA about.
Types Of Owner Financing
The following are the three most common types of owner financing:
An owner financing 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 to the lender.
That note would spell out the deal’s terms, including terms 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.
How Owner Financed Mortgages Work
There are several different ways to put together an owner financing mortgage. If the property is owned free and clear, meaning there is no underlying loan, it is simple.
This is because you won’t have to worry about an existing mortgage while also providing financing to the buyer, thereby giving you more flexibility to come to an agreement that works for both parties.
If there is an existing loan on the property, the seller will most likely want to pay that loan off before transferring the title. Otherwise, they take on a greater amount of risk since if the buyer defaults on the owner financed loan, it could cause the seller to default on their loan as well.
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, say you’re selling the property for $200,000 but you still owe $100,000 on your initial mortgage. If this is the case, you can have the buyer pay off your existing loan balance and then provide the buyer with owner financing for the remaining purchase cost of the property.
Or, the seller can bring in cash or a new loan from a different source to pay off the existing mortgage. 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, which means that if the borrower defaults, the second mortgage holder would need to pay off the first mortgage to get the property.
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 paid in cash or by using another loan.
- Pros For Buyers
The pros for purchasing a home using an owner financing mortgage are many. One of the benefits is that 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 even if you don’t qualify for traditional mortgage loans. You can also negotiate better terms, save money on fees, keep the debt off your credit report, and close quickly.
- Pros For Sellers
As a seller, 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.
A land contract, also known as a contract for deed, is a bit more complicated. With this type of arrangement, the buyer will have most of the rights as the owner but won’t actually be on title. The buyer won’t get the deed to the house until the contract is satisfied and paid in full.
For example, if you buy a new car using a loan, then technically you’ll own it. This 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 the car is paid for in full.
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 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 a mortgage. You will have full use of the home and even get all the tax benefits of owning it, but 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 for a seller is a longer foreclosure timeline, so I would suggest speaking to an attorney before moving forward with a land contract as a seller.
Lease-Purchase Agreements (Rent To Buy)
I love the rent-to-buy strategy because it is easy to understand and agree to. The arrangement is an agreement for the owner to rent the home to a tenant for a set monthly rate (keep in mind, this rate is not the same as rent since it’s to purchase the house).
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 per month with no cash or credit while still in school. 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 (but 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, 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 all over again.
Things To Be Aware Of With Owner Financing
Although owner financing is a fantastic strategy, there are risks for both the buyer and seller:
Because you can negotiate 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, you could lose the house if you default on the loan.
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.
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).
Questions To Consider With Owner Financing
Owner financing can certainly be beneficial, however it’s not without its potential drawbacks. There are some issues that could arise that you’ll need to be aware of. The following are three essential questions that you must ask yourself before pursuing owner financing:
Who Holds The Deed To The Property?
In general, the seller will hold the deed to the property until you make the final payment or you refinance the loan. However, you could find yourself in quite a mess if it turns out that the owner you’re financing from doesn’t actually own the property outright.
What happens if you’re financing from an owner whose wife actually holds the deed – and they end up getting a divorce? Find out who actually holds the deed before you agree to any type of owner financing.
Who Pays For The Property Taxes?
Another thing that you need to find out is who will be responsible for paying the property taxes. In some cases, it may make sense for you to pay the taxes while the seller pays the insurance. It really depends on your specific situation. However, you need to make sure that this is clearly specified before you sign anything.
What If The Buyer Defaults?
If you’re the seller, then you need to think about what will happen if the buyer defaults on the loan. What are your options? Can you take back the property? Are there any legal ramifications that you need to be aware of?
If you still owe money on a mortgage, then you could end up in a very difficult situation if the buyer defaults. Make sure you understand your rights and options before you agree to anything.
How To Find Properties That Offer Owner Financing
If owner financing is something that you’re interested in, then you’ll need to find properties that offer this type of financing. One of the best ways to do this is to search for properties online using specific keywords.
The following are a few search terms that can help you identify owner-financed properties in your area:
- Owner-Financed Homes: This keyword will bring up properties that are specifically advertised as available for owner financing.
- Seller Financing: This keyword will bring up properties where the seller is open to financing arrangements.
- For Sale By Owner (FSBO): This keyword will bring up properties that are being sold by the owner, without the involvement of a real estate agent. These types of properties are often more negotiable, which could make owner financing more of a possibility.
Is Owner Financing Right For You?
Owner financing is another tool in the real estate investor’s tool belt. While not a perfect fit for every situation, every investor can benefit from understanding more about 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.
At Pine Financial Group, we are real estate investor financing experts. We are more than happy to go through the specifics of your deal and discuss possible financing options.
Choose the financing option that best fits your needs. Explore your options with us today!