How Does Owner Financing Work?

How Does Owner Financing Work?

Owner financing is becoming increasing popular in today’s economy due to how difficult obtaining a conventional mortgage has become.  In order to qualify for most conventional mortgages, a person must have a certain credit score, must have employment for a certain number of years, and must be able to put 20% down on the property.  Also, they must hope that the bank comes up with the same appraisal value of the property that everyone else in the equation does, or the loan will fall apart.  The fact is, there are so many things that need to go right in order to obtain a loan that many people are turning to an alternative: owner financing.  After all, in a free and competitive society, isn’t the ability to create new avenues in order to solve problems the backbone of capitalism?  With that in mind, let’s answer the question ‘how does owner financing work?’

How Does Owner Financing Work | Conventional Mortgage

Before we discuss owner financing, let’s first explain how a conventional mortgage works.  Then we can explain the differences between a conventional mortgage and owner financing.

In a conventional mortgage, a seller agrees to sell a house to a buyer for a price.  When the sale is complete, the new buyer obtains a ‘deed‘ to the house.  The buyer goes to a bank to obtain a loan for the purchase, using the house as collateral should the buyer ever default on the loan, and the seller is then paid in full at the time of the transaction.  This loan is known as a mortgage.  The buyer will obtain the deed to the house when the sale occurs along with the mortgage and will typically pay both principal and interest on the mortgage for the next 15-30 years.

How Does Owner Financing Work | What is Owner Financing

In a typical owner financing transaction, a seller agrees to sell a house to a buyer for a price.  So what is owner financing?  Instead of the buyer seeking financing from a bank, the seller would agree to and create an owner financing contract to sell the house for a price and agree to installment payments in lieu of a full price payoff.  So how does owner financing look?  Here’s an example:

• Sales Price:  $155,000
• Down Payment:  $15,000 (includes $5,000 for closing costs)
• Note Value: $140,000
• Interest Rate: 8%
• Balloon: 5 year

Once the terms are agreed upon, the signing of the documents will take place in front of a notary and the paperwork will then be filed at the courthouse.  In many instances (though not required – but highly recommended), owner financing deals will be closed at a Title Company.

How Does Owner Financing Work |Benefits

The benefits of this type of transaction is ease and convenience.  First, there are only 2 parties involved- the buyer and the seller.  There are no banks, appraisers, insurance companies, underwriters, etc… that turn the mortgage part into a nightmare.  Instead, you have two parties that can make offers and renegotiate quickly and efficiently until they both agree.  Then they can both close quickly.  A typical owner financing transaction can be completed, start to finish, in a matter of days.  The seller benefits because installments loans at 8% pay better than putting the money in a bank account and is safer than putting it in the stock market.  The buyer benefits because they’re obtaining a home they otherwise could not have purchased through conventional methods.

How Does Owner Financing Work | Wrap Around Mortgages

Suppose you are in a situation where you owe $150,000 on a house that is only worth $150,000.  If you were to sell with the assistance of a Realtor and wait for a conventional mortgage to be approved, you would typically wait 6 months (6 more months of expenses) and pay 7.5%, or over $10,000 to sell your house.  If you are selling because you can’t afford to continue making payments and have no money in the bank, then this process doesn’t work well.  This scenario is too common in today’s economy and is a reason for the record amount of foreclosures.  What if you could sell your house fast without having to come out of pocket?  How does owner financing work in this scenario?

Remember above when we defined what the deed and mortgage were.  Did you know that you can sell the deed to a property while keeping the existing mortgage in place?  Then the seller can create another owner financed note that wraps around the existing mortgage.

How Does Owner Financing Work | Wrap Around Mortgage Example

Here’s an example:

Suzy Seller owes $100,000 on her house (interest rate of 7%) that is only worth $95,000.  She has no money in the bank and can’t afford to pay the $5,000 deficiency and $7,500 closing costs for a conventional sale nor can she wait 6 months for the deal to close.  If Suzy Seller is seeking a conventional solution to her problem, then her home  will wind up in foreclosure, a scenario in which everyone loses.  If Suzy Seller wants to sell her home fast without coming out of pocket (and avoid foreclosure), then she will need to sell her house with owner financing in place.

Suzy Seller finds Barry Buyer who wants to buy the home.  Barry is self employed with a 680 credit score.  While Barry has money in the bank and a good history of paying his bills, no bank will touch him because he is not ‘employed’ by a company.  Therefore, if Barry Buyer wants to buy a house, buying a home with owner financing is his only solution.

If you’re a real estate professional, can you imagine the problems that you could solve being able to match these types of people together?  From a business perspective, the bigger the problems that you solve, the more money you make…

In this situation, Suzy Seller and Barry Buyer agree to a sales price of $100,000 with an interest rate of 8% and will close in one week.  Barry Buyer agrees to put down a $2,500 and pay the title company their closing fees.  Now, Suzy Seller has made $2,500 selling a house that she would otherwise would’ve lost to foreclosure or had to pay over $12,000 to sell (not to mention 6 months worth of expenses).  Barry was able to find a house that he can afford but otherwise would not have been able to purchase through conventional means.  The neighborhood benefits because a real estate transaction occurred at market price rather than a foreclosure happening at a reduced rate.

How Does Owner Financing Work | Conclusion

In this tough economy, there are records amounts of people who have little, no, or even negative equity in their homes but need to sell.  Conversely, people still want to purchase homes, but due to stringent loan requirements by banks, they are able to obtain financing.  In a free market society, new alternatives are created in order to provide solutions to problems.  Owner financing allows ‘unsellable’ homes to be sold to ‘unloanable’ buyers, thus allowing real estate transactions to occur where foreclosures may have otherwise taken place.  Great amounts of money is made by solving problems such as these and understanding how does owner financing works will solve some of the biggest problems facing this economy.