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Owner Financing: A Complete Guide

Holly Shuffett8-Minute Read
September 21, 2021

With so many moving parts, it can feel extremely difficult or downright overwhelming to navigate the housing market and secure a home. You may even view the home buying process as a barrier which renders homeowning merely aspirational.

If you’ve ever felt like this – like becoming a homeowner is something unattainable due to inflexibility from financial institutions or not being able to find a mortgage that works for you – then you may be interested in pursuing seller financing.

What Is Seller, Or Owner, Financing?

Seller financing – also known as owner financing, bond-for-title or owner carryback – is a residential real estate agreement solely between the home buyer and the home seller, in which the seller replaces a third-party lender by financing the home’s purchase for the buyer.

Selling financing allows the home buyer to circumvent traditional mortgage lenders and instead pay the home seller, typically in installment plans over a shorter period of time. Also unlike with the traditional mortgage process, seller financing is not as highly regulated, which can come with numerous risks and benefits to both parties.

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How Seller Financing Works

Like everything in real estate, the appeal of seller financing fluctuates with the current state of the market. Since mortgage lenders adapt their risk assessments for lending over time, whether or not you’re able to secure a loan may vary depending on when you’re looking to purchase a home.

Seller financing typically increases during periods of economic downturn, when financial institutions may be more reluctant to lend money, and it decreases when lenders are less strict or have more attractive rates.

How Does Seller Financing Differ from A Mortgage?

Unlike with a traditional mortgage, there are no banks or third-party lenders involved in seller financing. This erases the need for a bank loan officer, underwriter or legal department, and usually allows the home buyer to actually get into their home quicker and with fewer built-up fees.

With seller financing, ownership will still transfer to you, the home buyer, as normal, except instead of making payments to a lender you’ll simply make those payments to the home seller.

What’s In It For The Seller?

What would a home seller gain from this arrangement? Simply put, the seller is protected with a mortgage lien on the property and is agreeing to wait and finance your payment in exchange for making some money long-term off of your agreed-upon interest rates.

However, seller financing is an arrangement which only works when the home seller owns the property free and clear. If the seller themselves has an existing mortgage lien on the property, since there is an existing lien owner, you won’t be able to do a seller finance purchase as it’s not technically their property to sell.

The Seller Financing Process

A seller financing agreement is usually fairly short-term and typically lasts no longer than 5 years with a balloon payment at the end. And just like in a conventional real estate transaction, a seller financing arrangement begins with a down payment.

You’ll want to have a discussion with the home seller to determine the amount you’ll need to present upfront – while it’s possible that a seller may take on the full purchase and wave the down payment altogether, most sellers ask for between 5% and 10% to show that you, the borrower, is financially committed. But when compared with standard real estate agreements, the down payment for a seller financing deal will be significantly lower.

The next step in the seller financing process usually requires the aid of real estate experts – both parties should enlist the help of an experienced real estate agent or a real estate attorney to draw up a sales contract and a promissory note.

A promissory note is a document which keeps track of all the terms and conditions the home seller and buyer have agreed upon. Similar to a Closing Disclosure, a promissory note will include information regarding established interest rates and a payment schedule with respective consequences or fees for any late or missing payments.

In most cases, a 5% interest rate is pretty good, but you should negotiate the interest based on your plans with the property. If you’re a flipper looking at the property as a short-term investment, you can afford a higher interest rate as you’ll most likely only have the property for a few months to a year. But if you’re planning on living in the home long-term, you’ll want to try and negotiate that rate down.

Lastly, and very importantly, is defining the maturity date or due date for your loan – otherwise known as the balloon or balloon payment. Simply put, the balloon is how much time the home buyer gets to pay off their loan. A 5-year balloon is typical in seller financing, but if you expect to hold the property deed long-term, try and negotiate the highest balloon possible.

These are all important factors to consider and understand before negotiating with the home seller. Oftentimes, these factors will have interdependent relationships – if you want a low or waived down payment upfront, you may have to agree to a higher interest rate. You should also be aware of your plans for the property – is this a long-term or short-term purchase? – in order to negotiate the best terms for your circumstances.

The Pros And Cons Of Owner Financing For Homebuyers

Seller financing is an unconventional method of lending for home buyers, but that’s not to say it won’t work for you. This lending option presents both benefits and risks for the home buyer. Let’s take a look at the pros and cons of seller financing, and when it may be a good idea for you.

Pros

  • The closing process will be much quicker and cheaper than with a conventional mortgage lender.
  • You won’t need to raise as much capital for a down payment as you would with a typical mortgage.
  • You can expect fewer or even no closing costs depending on your situation.
  • Seller financing may not require a home appraisal.
  • Home sellers are usually more flexible with their lending terms than a bank or a third-party mortgage lender.
  • There is a potential for no private mortgage insurance (PMI).
  • Seller financing can be extremely advantageous in a tight credit market.

Cons

  • In most cases, a seller financing deal will have higher interest rates than with a standard mortgage.
  • You have to do your research and ensure that the seller owns their property free and clear, and that they are able to finance the sale.
  • The risk for any unknown encumbrances may subject the property to foreclosure.
  • The Center for American Progress has dubbed seller financing as “predatory.”
  • Balloon payments can be extremely daunting if you haven’t thought through your timeline or financing.
  • You must have a good working relationship and communication with the home seller.
  • You may have to sell yourself as a borrower to the home seller – this could include earning their trust or impressing them with your commitment to the home.

With all of these pros and cons, when is it a good idea to pursue a seller financing purchase?

Seller financing is usually most attractive for those who may have trouble obtaining a conventional loan either due to poor credit or a particularly risk-averse market. However, many investors, flippers or home buyers looking to get into a home quickly can also benefit greatly from a seller-financed sale, as it’s a short-term agreement in itself.

How To Calculate Owner Financing Payments

Step 1: Collect The Necessary Numbers

To properly calculate the payment for a seller-financed purchase, you’ll first need to gather the following information from the land contract or your promissory note, otherwise known as the mortgage note:

  • The interest rate. The agreed-upon interest rate is determined by the home seller and the home buyer. Interest rates are influenced by factors such as your credit history and the established down payment for the purchase.

  • The loan term. The loan term is simply however long the seller has agreed to finance your loan. Same as with traditional mortgages, the loan term for a seller-financed transaction can vary, though terms of 5, 10, 15 and 30 years are typical.

  • The loan amount. If your seller is financing the full purchasing price of the home, the loan amount is the full price of the home minus whatever you put in the down payment. Otherwise, the loan amount is whatever the home seller and buyer have agreed upon.

  • The number of payments. The total number of mortgage payments you’ll make. If you have monthly payments, then N will be your loan term multiplied by 12.

Step 2: Multiply Loan Amount By The Interest Rate

For example, if a seller-financed loan is for $100,000 at an interest rate of 8%, you would calculate that $100,000 x 0.08 means $8,000 in interest for the year.

Step 3: Divide By 12

In this scenario, a $100,000 loan at 8% would look like $666.67 in a monthly interest only payment. Keep in mind that you’ll want to try and pay more than just the monthly interest payment each month in order to make the loan amount, or the principal balance, go down over time.

Tip: Be Wary Of Balloon Payments

In order to set yourself up for success during a seller financing arrangement, you should have a plan for refinancing or building up equity by the time your balloon payment comes due. It’s also important to note that for real estate investors or on hard money loans, balloon payments are typical.

How To Find Owner-Financed Homes For Sale

When it comes to establishing a seller-financed offer with a home seller, you first need to learn whether the seller owns the property free and clear. Once you have that information, you can make a cash offer, but explain that if the seller is willing to enter a seller-financed arrangement that you’d be willing to pay more for the home. This will usually open the door for further discussion on owner financing.

You could also present the seller with a budget and concept for any repairs or renovations you’d want to make on the home, which would in turn increase the equity or value of the property. Not only would this show that you’re financially committed to making a deal with the seller, but in some cases, it could even replace a down payment as proof that you’re invested in purchasing the home. At closing, you could even put the money for renovations in escrow to reassure the seller that that money will in fact be used toward the house.

The Bottom Line: Owner Financing Could Be The Right Option For You

Owner financing is an unconventional loan method, but one which bypasses the need for bank or third-party involvement. This short-term method of lending can benefit both the seller and the buyer if the terms are right and is a great way to save money for house flippers or property investors.

Owner financing is also a great option for those of us who don’t have cash on hand for a sizable down payment, or for those who have been turned away from lenders due to poor credit or a strict market.

Remember to do your research, ensure that a home seller is free and clear, and enlist the help of real estate attorneys or professionals. You’ll also want to use the time leading up to your balloon payment to build up equity and boost your credit score for an improved refinance rate. Check out the Rocket Homes Home Buyer’s Guide for more homeowner tips about financing.

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Holly Shuffett

Holly Shuffett is a freelance writer for Rock Companies where she usually covers lifestyle and personal finance topics. Holly is also an Oakland University senior pursuing public relations and journalism, and she is interested in learning more about the entertainment and travel industries. In her free time, Holly serves as the secretary for Dance Marathon at OU, is a member of PRSSA, and tutors part time for Dictionary.com.