What is Owner Financing in Real Estate?
In the majority of real estate deals, a piece of property will be sold or purchased with either cash or bank financing. In the event that a buyer is unable to purchase the property outright due to inadequate funds, they will be subject to extensive bank underwriting before they can qualify for the loan. However, there is a third option for selling or buying a home, and this is through owner financing. Below is an overview of what it is and when buyers and sellers should use it.
How Does Owner Financing Work?
Also called seller financing, owner financing is a procedure for financing the property in which the owner retains the purchaser’s loan. It is similar to bank financing, with the difference being that the purchaser will compensate the seller through monthly payments which occur over a set time span with certain terms and an interest rate that both parties agree to. This type of financing is frequently used by investors but can be done by others.
Although it isn’t as common as traditional approaches, it is certainly viable and highly effective when done correctly. In fact, research conducted by Advanced Seller Data Services indicates that approximately $26 billion worth of seller-financed loans are made each year in the U.S. This form of financing has no restrictions with regard to who can use it or what properties are eligible. This means you can purchase or sell apartments, self-storage units, single-family homes, or a four-plex.
When Should You Use Seller Financing?
Seller financing is ideal in situations where the buyer can’t qualify for conventional loans due to prior bankruptcy, economic issues, or stringent lending guidelines. The financing structures come in three forms: lease options, mortgage and note, or a land contract.
Lease Option: With this arrangement, the purchaser will lease the property for a time with the intent to buy. They and the seller will make an agreement regarding the final price prior to the lease going into effect. Once it expires, a purchaser may acquire the property or forfeit the lease along with any funds which were rendered into the agreement. Should the purchaser decide to pay for the property outright, the funds paid during their lease period may be applied to the final purchase price.
Mortgage and Note: This financing method is the most secure, and is similar to the procedures used by banks. The seller will draft a note which specifies the amount which is borrowed and the repayment terms. The mortgage will securitize sellers should the purchaser default, and the purchaser will be placed on a deed and title with the mortgage being recorded inside public records.
Land Contract: This arrangement is similar to a mortgage and note. However, the difference is that rather than a purchaser obtaining a title for the property, sellers will stay on the title until the purchaser has fully repaid their debt.