What Is Owner Financing And Is It A Good Deal?

by Neal Frankle, CFP ®

More and more people are asking about owner financing in real estate. That’s happening for two reasons:

1. Buying the right real estate right now could still be a brilliant move.
2. Banks still aren’t making it easy to qualify for a loan.

That means more people want to invest in property but a growing number of these eager buyers find it increasingly difficult to do so. That’s why buyers are trying to find sellers who will finance real estate deals.

What is owner financing?

It sounds very fancy but it’s actually really simple. Owner financing is when the seller carries the mortgage. Let’s say you want to sell your home to a great buyer but she can’t get a loan from the bank. If you as the owner become the bank and carry back the mortgage you facilitate the sale that otherwise wouldn’t go through.

Can anybody do this?

Yes and no. If you want to stay within the strict definition of owner financing, the seller needs a ton of equity in the property in order to make this happen. Here’s why. If they sell a property that has a large mortgage on it, they are going to have to use someone’s cash to pay that mortgage off before they can transfer ownership to the buyer.

In a traditional arrangement, the buyer gets a loan and uses the proceeds to pay off the seller’s mortgage. But if the buyer can’t get a loan from a bank, somebody else has to cough up the dough. So if the buyer wants to provide financing, they need to have the cash to pay off any outstanding mortgage balance.

What If The Seller Doesn’t Have The Cash To Pay Off The Existing Loan?

In that case, the seller can’t really sell the house to another person who can’t get a mortgage. But their hands aren’t tied completely either. In this situation the only arrangement that might work would be for the seller to do a lease option to buy. This is known as selling options on real estate and it gives the buyer an option to purchase the house at a set price within some period of time.

Before you buy or sell a house using owner financing, determine the credit score of the buyer. This helps both parties. The buyer can negotiate from a stronger position and the seller will feel more comfortable knowing who he or she is dealing with. Here’s a way to get a credit score for free without signing up for trials and without using your credit card.

The buyer could exercise the option sometime in the future (buy the house) if either the buyer expects to be able to qualify for a loan at some later date or the seller expects to be able to pay off the existing mortgage herself and carry back the paper.

What are the risks of an owner financing a real estate transaction?what is owner financing

There are risks to both buyer and seller. First, if the bank is saying that the buyer doesn’t qualify for a loan, maybe it’s for a reason. It’s true that even people with good credit might find it difficult to find a bank that wants to play nice with them these days. But you might prefer not to sell to someone who can’t get a mortgage because they have bad credit.

If the buyer plunks down a healthy wad of cash and then fails to make the payments, they could lose the down payment and the property. Aye yay yay.

And the seller also takes risk by entering into this arrangement. Again, if the banks aren’t willing to front a loan to the buyer, maybe it’s because they aren’t a good risk. If the seller takes back a mortgage from the person, they may have to foreclose and take back the home through a foreclosure process. That takes time and money and it’s a huge headache. Kapow! It also subjects the seller to potential income tax problems to boot. Double Kapow!!

Owner financing can be great for the right buyer and seller but it can be a disaster if conditions aren’t right. Usually, the people who enter this agreement do so as a last resort because they are desperate to make a deal. If at all possible, I suggest you seek other alternatives.

Have you purchased or sold real estate using owner financing? How did it work out for you? What would you do differently?

email

Subscribe & Get Your Free E-Book and E-Course as My Gift to You!

Investing Your Money Made SimpleOnce a week you'll get unique tips to make smarter money decisions about your investments, retirement, taxes, and career. You'll also get encouragement and ideas to help you get out of debt, earn more money, and generally stop worrying about your money.

Neal Frankle is a Certified Financial Planner™ with over 25 years experience. Subscribe today and tap into this wonderful, free resource!

Become a Fan! Follow @NealFrankle

{ 0 comments… add one now }

Leave a Comment


7 + seven =

Previous post:

Next post: