Owner financed is when the property’s seller finances the purchase with the buyer.
An owner financed purchase is also known as a seller financed purchase or an FSBO (For Sale By Owner) property. This means that the property owner acts as the bank. He or she may set the terms and rates of the sale.
Owner financed properties are usually more common when banks implement stricter lender practices or when buyers struggle to qualify for a traditional home loan.
The simplest way for an owner to finance his or her property is to own the home outright. For example, a buyer may want to purchase a home for $400,000. He can pay a 20% down payment of $80,000. However, his bank has only approved a $300,000 mortgage.
The seller may choose to finance the remaining $20,000 or the entire loan amount of $320,000. Whatever the loan amount, the buyer would make monthly payments to the seller for the principal amount plus interest.
On the other hand, there are complications if a mortgage is still held on the property. For example, the seller’s original mortgage may have a “Due on Sale” clause. His existing lender may demand the entire loan due if the homeowner transfers the title to the new buyer.
As a result, if the seller cannot produce the debt in full, the existing lender may foreclose on the property. If this happens, you, as the new homebuyer, would lose all equity that you have built up.
A title search on the property will confirm whether the property is available for owner financing.
There are distinctive benefits for owner financing for buyers as well as sellers.
When a buyer cannot qualify for a traditional loan, owner financing can help finalize the transaction.
Homeowners looking to sell their home may speed up the transaction and simplify the process by offering to finance the loan.
Since the owner is financing the loan, he or she receives monthly payments with interest. This would be more than the seller would likely receive if the buyer funded the loan through a bank.
Additionally, if the buyer defaults, the seller may keep the down payment, any money that was paid, and retains the title to the property itself.
In an owner financed property, there is much more negotiating power. Buyers typically save on closing costs by eliminating the intermediary.
In addition to low or no closing costs, the time it takes to complete the home buying transaction is much faster. Unlike a traditional mortgage, you do not need to wait for the underwriting and legal department to investigate your financial history and approve your application.
There are limitations for both buyers and sellers for an owner financed property.
The bank traditionally takes on the risk of missed payments and default in the home buying experience. However, owner financed properties eliminate the institutional lender. As a result, the seller takes on the borrowing risks.
Sellers may require a more substantial down payment to help mitigate some of the risks.
Traditional lenders may require the seller to make a few repairs before closing. However, without this sale contingency, the buyer must accept the home in the current condition.
Many owner financed contracts are short term. The loan may be amortized over 30 years but come with a final balloon payment due after five years. Ideally, the buyer would be able to use these five years in order to qualify for a traditional mortgage by improving their credit score and building equity in the home.
A large balloon payment is a risk for the buyer to be able to afford the home once the owner financing period is complete.