Your new home is one of the biggest investments you’re likely to make. Typically, such an investment requires some type of financing. The most common type of financing is a traditional bank loan. However, for those who are unable to get traditional financing, alternatives exist. One such alternative is seller financing. If you’re in the market to buy a new home and have seen homes for sale by owner, you may wonder what this means and if it is a viable option for you. It certainly sounds easier than bank financing. Read on to learn more about owner financing to decide if this is an option you should consider.
How Does Owner Financing Work
The unique aspect of owner financing is that there are no formal requirements. You aren’t required to have a certain credit score. You don’t necessarily even have to have a down payment. However, the seller will usually ask for a large down payment and want to see a credit score above a certain number. But, with owner financing, there is room for negotiating the interest rate, the down payment and length of the loan as well as the selling price. Owner financing is usually offered when the seller has satisfied their mortgage with the bank. The seller may ask for a down payment to pay off any outstanding mortgage. The following are steps taken with seller financing:
- The seller extends credit for the price of the home, excluding the down payment
- The parties sign a promissory note that states the terms of the loan
- The parties will then sign a deed of trust
- The buyer is required to make monthly payments with interest until the loan is satisfied
The seller can finance all or a portion of the selling price of the home. Most seller financing arrangements require the buyer to come up with a balloon payment after a certain time period which is usually five years. This is because the seller may not be as patient as a traditional lender and they don’t want to wait 20 years for you to satisfy the loan. They may want or need the money sooner than you can pay the loan in full. Therefore, it is at this point that you would be required to obtain third party financing or other financing arrangements. Failing to do so means you could lose all the money you’ve paid and also the loss of the home. For this reason, make sure you fully understand the terms required by the seller before you enter into such an arrangement. Seller financing is a great way to build your credit rating. So, even if you weren’t able to qualify for traditional financing when you agreed to the owner financing arrangement, chances are your credit rating will be high enough at the end of the five years to allow you to obtain third party financing.
Types of Owner Financing
There are a few types of owner financing available depending on the type of property you are trying to acquire. These are lease purchase agreements, land contracts and a deed of trust.
- The lease purchase agreement, more commonly known as rent to own, is a great option if you’re not quite ready for a traditional mortgage. With this type of owner financing, you pay an option fee which secures your right to purchase the property at the end of the lease. This fee is generally one to two percent of the home’s selling price. The seller could also require other up-front payments, such as a down payment, security deposit and first month’s rent. You make regular payments according to the terms of the lease. The seller may apply a portion of your rent payments towards the purchase price of the home. At the end of the lease, if you elect to purchase the home, you will obtain traditional financing, pay with cash or other financing option of your choice.
- A land contract allows the buyer to obtain an equitable title and take possession of the property. The buyer is then required to make payments to the seller for a specific period. Legal title to the property will only be conveyed once the buyer obtains third-party financing or makes the final payment.
- A trust deed is a written document used to secure a loan on a property. There are three parties involved in such a transaction. They consist of the trustor (buyer/borrower), the beneficiary (seller/lender) and a neutral third party referred to as the trustee. The trustee holds the bare legal title to the property to be held as security for the lender until payment has been fulfilled. At such time, the title will be transferred to the buyer.
Why Would Someone Need Owner Financing?
A person looking to buy a home may seek owner financing for several reasons. A major reason owner financing can be an attractive option is if the buyer is unable to obtain traditional financing through a bank. In order to obtain a traditional mortgage, you have to have a good credit score and in most instances, you will need to come up with a down payment and other upfront costs associated with obtaining a conventional loan. Some people do not have cash readily available to cover these out-of-pocket costs. Not only are you required to have money on hand for such expenses, but you also must commit for a long time to pay off your mortgage. Some people may have a difficult time committing. In these instances, it only makes sense to seek owner financing. You can negotiate the terms and aren’t fully committed as you would be with a traditional mortgage. Obtaining a loan through a bank or other lending institution is very challenging. The amount of paperwork that is involved can discourage even the most excited home buyers. With owner financing, paperwork and red tape is not an issue. Once the seller is satisfied that you can hold up your end of the bargain, then you are on your way to being a homeowner.
Benefits of Owner Financing
A buyer may benefit greatly from an installment sale transaction. Although such an arrangement often comes with a higher selling price and higher interest, there are advantages to the buyer that makes this option attractive to some.
- You can easily qualify for owner financing. An installment sale differs from conventional financing in that it does not require traditional bank income and credit approval. There are a number of reasons why a buyer cannot meet the strict requirements put in place by a bank. Perhaps, the buyer has been through a divorce or recently filed for bankruptcy. Also, if one is self-employed, they may have a difficult time proving their income. Or, if someone is new to a job, they may be unable to meet the strict guidelines of the lender. In such scenarios, owner financing becomes a very attractive alternative.
- Owner financing can give you the opportunity to improve your credit rating while making timely payments on your home and being a homeowner. This is especially important if the seller requires a balloon payment at the end of a specified time period that would mean you would have to obtain third party financing to satisfy the mortgage with the seller.
- Traditional loans come with many fees for which the buyer is responsible. Often, these fees need to be paid upfront. If you don’t have ready access to cash, this can be a difficult hurdle to cross when getting financing. Conventional lenders will charge you fees for points, origination fees, underwriting fees, credit reports, title insurance, appraisals and many other fees associated with obtaining traditional financing. You will not have any of these fees with owner financing, which is why this option is very attractive to home buyers. You simply pay the down payment and any other fees you agreed to pay the seller. Then you start making your monthly payments. There are no closing costs or hidden fees.
- Owner financing means you can get through the closing quickly and move into your new home. There is no third party involved to hold up the progress of your loan. With traditional financing, because of all the paperwork involved and underwriting, it can take up to three months to close a loan, and even longer if you fail to provide all the documentation required by your lender. A traditional loan application may have to go through several departments before approval is granted. With seller financing, you are dealing directly with the seller who makes the decisions and approves you as the buyer.
- Terms of the loan are flexible. You can negotiate with the seller on the down payment. Also, the interest rate, as well as the length of the loan, can be negotiated. Such terms are fairly rigid and depend on your good credit when dealing with third party financing. If the seller feels that you are trustworthy and are a good prospect, they may be more willing to negotiate the terms in your favor.
Shortcomings of Owner Financing
While owner financing is an attractive option for a variety of reasons, there are still some drawbacks for buyers. Some of those drawbacks include the following:
- You may be paying a higher interest rate than you would if you were financed through a bank. The seller may also ask for a larger down payment than what you would normally have to pay with traditional financing. It is solely up to the seller on how much to charge for the interest and the down payment and you will have to negotiate to get terms you are comfortable with.
- There may be a due on sale clause associated with seller financing. If the seller has a mortgage on the home, they will be required to notify their lender of their seller financing arrangement. The lender can then require them to satisfy the balance on their loan. If the seller fails to satisfy the mortgage, the bank can foreclose on the home. Therefore, it is best if you can research and make sure the seller owns the property free and clear or that their lender agrees to seller financing.
- More often than not, seller financing arrangements require a balloon payment to be made at the end of a certain time period, usually five years. This is the time when you would want to secure financing for such amount. If you’re unable to do so, the lender can take back the house which means you lose all the money you’ve invested up to that point.
The Bottom Line
Buying a home that is for sale by owner can help you get into a home faster than with traditional financing. If you have less than perfect credit this may be the right option for you. If you just want to get into a home and don’t want to wait for a traditional loan to be approved, which could take three months or longer, seller financing offers a quick closing and minimal information from you. Also, you may not be quite ready to commit to a long-term mortgage. Owner financing can offer flexible terms that can be negotiated in your favor. Although there are some drawbacks, this is a great option for some. If you’re considering buying a home that is for sale by owner, do your research. You don’t want to get stuck with a home for which the owner still owes the bank money because the bank can foreclose once it learns of the owner financing arrangement. Therefore, it is important to make sure the mortgage on that home has been satisfied or the bank approves of the seller financing arrangement. Either way, it is up to you to ensure the arrangement will work.
Owner financing can be mutually beneficial to the buyer and seller. The great aspect of such an arrangement is both parties have room to negotiate. There is no third party involved to complicate the process. The transaction can be closed quickly so that each party can get on with their lives and focus on more important matters.
This information is provided courtesy of The Eastside Real Estate Team. Keep us in mind for all your real estate needs. Call us today at 425-200-4093.