What Is Owner Financing?
Owner financing is a transaction in which a property's seller finances the purchase directly with the person or entity buying it, either in whole or in part. This type of arrangement can be advantageous for both seller and buyer because it eliminates the costs of a bank intermediary. Owner financing can create much greater risk and responsibilities for the owner, however.
How Owner Financing Works
A buyer might be very interested in purchasing a property, but the seller won't budge from a $350,000 asking price. The buyer is willing to pay that amount and can put 20% down—$70,000 that he gained from the sale of his prior home. He would have to finance $280,000, but he can only get approved for a traditional mortgage in the amount of $250,000.
The seller might agree to loan him the $30,000 to make up the difference, or she might agree to finance the entire $280,000. In either case, the buyer would pay the seller monthly, principal plus interest on the loan.
Owner financing is for just a short period of time in many cases until the buyer is able to refinance to pay the owner in full.
Advantages and Disadvantages of Owner Financing
Owner financing is most common in a buyer’s market. An owner can usually find a buyer more quickly and speed up the transaction by offering financing, but it requires that the seller take on the risk of default by the buyer.
The seller might require a larger down payment than a mortgage lender would to compensate for the risk. Down payments can range from 3% to 20% with traditional mortgage lenders, depending on the type of loan. Down payments can be 20% or more in owner-financed transactions.
On the upside, these transactions can offer the seller monthly cash flow that provide a better return than fixed-income investments.
Buyers typically have the greatest advantage in an owner-financed transaction. The overall terms of financing are usually much more negotiable, and a buyer saves on bank-assessed points and closing costs when she makes payments directly to the seller.
- Owner financing is sometimes referred to as “creative financing” or “seller financing.” It's typically disclosed in the advertising of a property when owner financing is an option.
- Owner financing requires that the seller take on the default risk of the buyer, but owners are often more willing to negotiate than traditional lenders.
- Owner financing can provide extra income to the seller in the form of interest and can move a property more quickly in a buyer's market.
Requirements for Owner Financing
An owner-financing deal should be facilitated through a promissory note. The promissory note will outline the terms of the arrangement, including but not limited to the interest rate, repayment schedule, and the consequences of default. The owner also typically keeps the property title until all the payments have been made to protect himself against default.
Some do-it-yourself transactions can be fully managed by the owner, but assistance from an attorney is generally advisable to ensure all of the bases are covered. Paying for a title search can be beneficial as well to establish that the owner/seller is, in fact, in a position to sell the property and that he can eventually release title in exchange for financing some portion or all of the deal. (For related reading, see "Pros and Cons of Owner Financing")