What is Owner Financing?
To simplify it as much as possible, owner financing is when the seller of the house provides the loan to the buyer. The loan may be in conjunction with or in place of a mortgage taken from the bank.
Of course, when the seller is the lender, the typical circumstances surrounding closing change. Usually, both sides save time and money from avoiding standard closing costs. First, the owner doesn’t get all of his money up front, but instead receives payments plus interest over a period of time, just as a bank would receive from the borrower. Usually, the lender offers a better rate—or at least a better total package—than the bank can offer. Hence, owner financing is really only viable for sellers who have some extra cash on hand.
The buyer, in turn, does not have to deal with securing a loan from the bank. Because the transaction is with another individual, the deal is much more flexible to negotiation from both sides.
How Does the Seller Benefit?
- The seller may earn a higher selling price in return for offering the buyer a lower interest rate and allowing the buyer to avoid the bank.
- Assuming the buyer can make all the payments, financing may be a safer option than other forms of investment. For example, if the owner can be assured of a 6% return, he may choose to finance the buyer rather than get his money in a lump sum at closing. The steady 6% may be safer than investing that money in a riskier option, such as the stock market, which may not make him that high of a return.
- Because a third party will not be involved, the seller may be able to forego the inspections, appraisals, and insurance terms.
How Does the Buyer Benefit?
- The buyer has more bargaining power with an individual owner than with the stubborn bank.
- The buyer does not necessarily have to endure a tedious mortgage approval process.
- If the loan itself slightly favors the seller, the buyer can leverage the deal to get the seller to do some home improvements as exchange. The seller may also throw in other goodies, such as providing homeowners’ membership fees or installing high-speed wireless internet prior to vacating.
How is the Seller at Risk?
- The seller won’t get all the money upfront as he would in a typical bank mortgage. Hence, he will be unable to gain interest on or to invest the large lump sum that he would ordinarily receive.
- If the seller doesn’t own the home, he has to pay off the existing mortgage before selling it.
- The seller is at risk of the buyer defaulting. Whereas banks expect people to default and can still manage to turn profit when borrowers fail to pay, the individual seller is likely to be greatly affected by non-payment.
- If an emergency arises and the seller needs cash quick, he will have to sell the loan contract. Because the loan likely has a lower interest rate than the bank would provide, the buyer of the contract will discount the price he offers the seller.
- If the seller does not hire a lawyer to properly document the loan, he is at risk of the buyer taking advantage of a loophole.
How is the Buyer at Risk?
- Because a third party will not be involved, unless the buyer demands a home inspection, mortgage insurance, or an appraisal as part of the deal, these buyer safeguards will not be necessary to closing. The buyer would be at higher risk of getting a lemon.
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Owner financing really isn’t a complicated process. But it is only appropriate for certain situations. If the conditions are right for the buyer and seller, then owner financing can be mutually beneficial and profitable to both parties. **Sources: michaelbluejay.com, financialweb.com, Century 21
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