What is Owner Financing and what are the benefits?
If you are seeking to participate in a real estate transaction in today’s tough economic climate, then you are strongly advised to understand what is owner financing. In order to understand what is owner financing, let’s first explain how conventional real estate transactions work.
Traditionally, for a real estate transaction to occur, the seller and buyer would agree to a price with the seller being paid in full and the buyer obtaining the deed at closing. To make this process work, the buyer would then obtain financing from a third party, typically a bank, in exchange for paying interest on the loan and using the deed as collateral to the loan should the buyer default.
This system is pretty close to broken in today’s economy. The banks heavy reliance on high credit scores eliminates more than half of Americans right off the bat. In addition, banks will only lend to people who are employed (not the self employed) and who can afford to put down a sizable down payment. It’s estimated that more than 75 million Americans are eliminated from contention for a loan. However, this doesn’t mean that these folks don’t want to purchase a house.
With this much demand for finding financing, it’s no wonder that an alternative form of buying and selling a house has gained in popularity. This article will answer the question ‘what is owner financing’ and detail the benefits of owner financing for both the buyers and sellers.
What is Owner Financing?
Owner financing is essentially when the buyer and seller agree to the sale of a house where both parties agree to installment payments rather than payment in full for the transaction to occur. This type of owner financing transaction occurs between the buyer and seller and does not involve a banks.
Let’s say that Sammy Seller owns a house free and clear and wants to sell the house for $100,000. Now let’s say that Betty Buyer loves this house, but is self-employed and only hs a credit score of 690. Betty Buyer can’t qualify for a loan. Sammy Seller would rather receive monthly income than the one time payment in full.
Sammy Seller and Betty Buyer can agree to a real estate transaction where Betty Buyer purchases the house for a $1o,000 down payment and installment payments (or mortgage payments) for the remainder of the $90,000 for the next 30 years at an agreed upon interest rate (which will typically be higher than market rate).
Why would the owner and seller agree to owner financing?
What is Owner Financing? | Benefits
The main benefits to both parties is the elimination of third parties. When you don’t involve huge bureaucracies, such as banks and government regulators, business transactions can actually be conducted quickly, efficiently, and painlessly. You can quickly make an offer, negotiate face to face on pricing and loan terms, and both parties have the authority to make final decisions. This efficiency means that both parties can negotiate in good faith, agree upon a deal, and close quickly. Also, owner financing transactions tend to put less focus on employment history and credit score and more focus on the buyers’ ability to pay their bills. This flexibility allows for more transactions to occur.
Typically, with greater flexibility leads to a higher interest rate for the buyer. But if the buyer is happy with the price and the house and can afford the interest rate, then it may be worth it to them to acquire the property they want for a higher monthly payment.
Obtaining monthly payments can also be a greater benefit to sellers than the lump sum. First, if they charge an 8% interest rate, then they are earning a better rate of interest on their money than they would through mutual funds, banks, cds, life insurance, or any other for of ‘investments’ with much less risk. After all, if the buyer defaults, then they can reacquire their collateral, or property, and resell again.
What is Owner Financing? | Wraps
Can you sell a house with owner financing if you have an existing loan? Yes you can. Many distressed home sellers who have little, no, or even negative equity on their homes want to sell but can’t afford to sell through conventional methods due to long holding costs and high closing costs.
For example, if you have a home that is worth $200,000 and you owe $200,000, by the time you pay Realtor fees and other closing costs (typically 7.5%), you will have to pay $15,000 to sell your house (not including the additional 4-8 months of holding costs waiting for the house to sell). If a distressed seller has no money in the bank and can’t afford to make monthly mortgage payments, then this method will lead to a foreclosure, which is a loss for all parties involved.
Selling a house with owner financing wrapped around the existing mortgage is known as an assignment of mortgage payment. In the scenario above, the seller could sell the house to a buyer for market price, have the buyer pay all closing costs, and wrap this new note around the existing bank mortgage. The benefits of the owner financing wrap to the seller is that they don’t have to come out of pocket to pay any fees, can sell quickly, and can avoid foreclosure. The benefits to the buyer is that they can purchase a house quickly without having to obtain a bank loan.
For more information on how an assignment of mortgage payments transaction works, you can watch this video.
