Owner financing occurs when the buyer of a property partakes in financing offered by the seller instead of making payments to a lender. Financing amounts can be for the entirety of the purchase price or a specified amount. Both parties must agree on the financing terms, such as the loan amount, interest rate, and amount and frequency of payments.
As a buyer, owner financing can be a good option if your credit or income does not meet a lender’s requirements. Sellers can also benefit, as it may help a property get sold more quickly or provide an additional source of income. However, rates may be higher for the buyer, and there could be complications for the seller if the buyer defaults on the loan.
Owner financing is also referred to by other terms, including seller financing, owner-carried financing, owner carryback, and owner will carry (OWC).
Types of Owner Financing
Various types of owner financing offer different advantages, payment structures, and legal obligations. Since owner financing can be a complex transaction in comparison to traditional mortgages, you’ll want to ensure you’re covered in the instance of any legal implications, so we recommended working with an attorney to facilitate the process.
This is a common type of owner financing where the seller of a property acts as a lender for the buyer. The buyer and seller must agree on the specific terms, such as a loan amount, interest rate, when payments must be made, the amount of each payment, and how long payments must be made.
Once both parties sign the agreement, the buyer will make payments to the seller, who retains title to the property. Once the loan has been repaid in full, the seller will transfer the title, and ownership of the property is transferred to the buyer. Holding mortgages are typically a form of short-term financing and are satisfied once the buyer can obtain another funding source.
This is a straightforward financing method in which a property buyer simply takes over the seller’s existing mortgage loan. The terms and conditions remain the same, including the interest rate and monthly payment amounts. Not all conventional mortgages are assumable, and assumable mortgages are mostly applicable only to government-backed loans. Notably, the current mortgage loan lender must also approve them.
One major benefit of an assumable mortgage is that it tends to be less expensive than a traditional mortgage. For example, the buyer will most likely not have to pay an appraisal fee and may get a lower interest rate than what other lenders currently offer for new loans.
Purchasing a property subject to an existing mortgage occurs when the seller remains legally responsible for the timeliness of the loan payments, but the payments are actually made by the buyer.
This is not a common form of financing because of the risks involved. If the buyer misses a payment, it will negatively impact the seller’s credit rating since the mortgage is still in the seller’s name. However, it can be an inexpensive way to finance a home and help a seller finalize the home’s sale more quickly.
With a wraparound mortgage, the seller’s existing home loan stays in place. The buyer then takes on a private mortgage loan from the seller. When the buyer makes payments to the seller, the seller can use that amount to pay the lender.
In most cases, the seller charges the buyer a higher interest rate than the lender is charging them. As a result, they can profit from the difference in the interest rates.
With a lease-purchase agreement, the buyer makes payments to the property seller in exchange for the right to purchase the property later. It can be thought of as a rent-to-own arrangement, where the buyer has the exclusive right to purchase the property in the future.
Monthly payments can be counted as part of the buyer’s down payment. With this type of arrangement, the buyer will obtain equitable title to the property. Once they can get a mortgage or other type of financing to satisfy the balance owed, the seller will then transfer full legal title to the buyer.
With a land contract, a buyer makes payments to the seller for the right to use a piece of land. Once the loan balance is satisfied, full legal title transfers to the buyer.
When Should a Seller Consider Owner Financing?
Offering owner financing as a seller can make it easier to sell your property. You might even be able to get better offers than if you were to require the buyer to obtain financing on their own through a bank. If you’re a seller, it may work for you if:
- You want to have a source of recurring income: With owner financing, you can receive recurring payments from your buyer faster. It can be a good alternative to investment property financing, a method that requires you to first acquire residential real estate for income purposes.
- You need to finalize the property sale quickly: You can get funding more quickly using owner financing since it eliminates the necessity of the many requirements and verifications lenders consider during the approval and disbursem*nt process. You can also spare yourself the hassle of facilitating various documentation and closing fees, saving even more time.
- You seek to get more offers for your property: By offering owner financing as a seller, you remove the requirement for a buyer to qualify for bank financing, which could attract more buyers interested in submitting an offer to purchase your property.
- You want to avoid making repairs to the property: Some lenders may not approve a buyer’s request for financing if the property they want to purchase is in poor condition. As a seller, offering owner financing can allow you to avoid coming out of pocket to pay for repairs and skip the necessary valuation process required of lenders.
Seller Pros & Cons to Owner Financing
| PROS | CONS |
|---|---|
| Negotiated interest rate can provide a higher rate of return than other investments | May require the assistance of an attorney to draft legal documents |
| Ability to finalize the property sale more quickly | Sellers carry the risk of a buyer defaulting on the loan |
| Property can be sold as-is | Existing mortgage may have a due-on-sale clause prohibiting certain types of owner financing |
When Should a Buyer Consider Owner Financing?
For buyers, owner financing can be a cost-effective way to purchase a property if you are otherwise unable to get traditional financing through a bank or other lending institution. This type of financing can also save you money upfront by eliminating many expenses associated with getting a mortgage from a bank, credit union, or other type of traditional lender.
Below are some additional circ*mstances in which a buyer may find owner financing to be beneficial:
- You want to finalize the property purchase quickly: Purchasing a property with owner financing can be done much more quickly since you won’t have to submit an application and wait for the verification and approval process like with a traditional mortgage loan.
- You have been unable to get approved for a bank loan: Owner financing has much more flexibility than banks regarding eligibility criteria. This can include things like credit score, income, and asset requirements. You can still purchase a property with owner financing if denied a bank loan and can negotiate terms with the seller that may be favorable to your needs and financial situation.
- You have insufficient funds for a down payment: Certain types of loans have minimum down payment requirements. Although this can vary on a case-by-case basis with owner financing, it can still allow you to purchase a property with a smaller down payment than you would otherwise need with traditional financing methods.
- You want to save money for other expenses: Owner financing can have fewer closing costs when compared to getting a loan from a bank. This is because you can avoid many of the costs associated with verifying eligibility for the loan, such as appraisals, flood certification fees, and lender underwriting fees.
- You can get a lower interest rate: Depending on the seller, you may be able to negotiate a favorable interest rate in comparison to other real estate loans. While it’s not always a lower rate depending on the loan type, there is room to find a rate within your budget. Head over to our guide on commercial real estate loan rates to learn more about how rates are determined.
Buyer Pros & Cons to Owner Financing
| PROS | CONS |
|---|---|
| Closing costs can be less expensive than a bank loan | Interest rates can vary depending on the seller |
| Easier qualification requirements | Typically requires shorter repayment terms of 10 years or less |
| Ability to close more quickly | Loans may have a final balloon payment |
| Can finance properties and borrowers that would not qualify for a traditional bank loan | Difficult to know what requirements the seller may have |
| No formal application process | Less common type of financing that can be difficult to find and negotiate |
| Repayment structures can vary depending on your ability to repay the loan | Contracts can be complex and require the assistance of an attorney |
Buyer Alternatives to Owner Financing
If you are a buyer and not convinced that the benefits outweigh the downsides, here are some additional types of financing you can consider. These financing options can offer varying rates and the ability to work with a knowledgeable loan advisor to get you into a loan best suited for your goals.
Type of Financing | Maximum Loan Amount | Estimated Starting APR | Minimum Credit Score | Maximum Loan Term | |
|---|---|---|---|---|---|
| Multiple | $5 million | Varies | 600 | Varies |
Commercial real estate | $10 million | Varies | 700 | 25 years | |
| Hard money/fix and flip | $2.5 million | 10.24% | 660 | 18 months |
Owner Financing vs Traditional Loans
Owner financing and traditional bank loans typically have notable differences in loan characteristics. This includes funding speed, rates, fees, and other loan terms.
Traditional Bank Financing | Owner Financing | |
|---|---|---|
Interest Rate | 8.5% and up | 5% and up |
Loan Amount | Varies | Typically under $1 million |
Repayment Term | 30 to 35 years | Typically under 10 years |
Required Down Payment | 0% to 20% | 0% to 10%, but can vary |
Closing Costs | 1% to 3%+ of the loan amount | $250 (legal fees) to 1% of the loan amount |
Minimum Credit Score | 600+ | None, but can vary |
Required Debt Service Coverage Ratio (DSCR) | 1.25x | None, but can vary |
Funding Speed | Up to 30 to 60 days | Under 7 days |
Owner financing can be a cost-effective way to purchase a property if you are otherwise unable to get traditional financing through a bank or other lending institution. That said, if you’re looking to cut down on costs and get approved at a lower rate from a bank, see our guide on how to get a small business loan.
Frequently Asked Questions (FAQs)
Owner financing involves purchasing a property and making payments to the seller instead of to a lender. This provides financing opportunities outside a traditional mortgage loan, although you’ll still make payments and be charged an applicable rate. You’ll need to find a seller willing to pursue this option and negotiate the specific financing terms. We recommend that all parties hire an attorney to draft and review the legal documents to ensure everyone’s interests are protected.
No. Since financing is issued via the seller instead of a lender, there’s room for negotiation when determining the applicable interest rate. However, you should charge a rate based on the Applicable Federal Rates, which are inclusive of private transactions. Also, depending on the state, there are regulations as to the maximum interest rate that can be charged. See to it that you do your due diligence depending on the location of the property to ensure you comply with federal and state regulations.
For properties purchased through owner-financing, the buyer is responsible for making tax and insurance payments.
Bottom Line
Owner financing, also known as seller financing, can be beneficial for both buyers and sellers. It can allow buyers to purchase real estate if conventional financing is not an option. For sellers, it can expedite the sale of their property and serve as a source of investment income. However, this type of financing also carries risks. If you’re considering owner financing, we recommend hiring an attorney to assist with preparing and reviewing the paperwork and any other legal documents.
