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Introduction

By Robert Duplicki      May 24, 2024

Based on a recent Google search, owner financing is a relevant topic right now. Here are three recent articles I have reviewed:

Owner Financing: What It Is And How It Works Forbes.com 6/9/23

Owner Financing: What It Is And How It Works Bankrate.com 2/28/24

What I Owner Financing? Business Insider March 18, 2024

This article from NoteSolutions gives you my comments to help you better understand these concepts, and to facilitate your own ideas. Sprinkled throughout are valuable links depending on your needs.

Owner financing is also known as seller financing. In the Google search mentioned above, you will also find first page results with seller financing in the titles.

I find value in each of the three articles selected, and I think that many of you will as well. However, there is only so much space in each article, and plenty of other insights and views to consider. Such articles can be limited to residential property while readers may have other needs which I address.

Basic Ideas

Depending on your background and your attitude you can start using owner financing rather quickly. The buyer and seller of a business, or residential or commercial property, can agree to terms and have an attorney structure the paperwork.

How much learning you need to do first will vary. There is always the concern that you don't know what you don't know. But no matter how well prepared you are to buy or sell anything, the results may turn out differently than expected, at least in some ways. Should this stop millions of such transactions from happening annually in the United States?

On the other hand, you can read all the articles listed above, and still be missing helpful information. Such articles usually say little about selling the promissory note used in owner financing documentation. So you also miss out on the helpful perspective of experienced note buyers, and how that would help you do owner financing. My intent is to offer you such insights.

I will refer to some quotes and topic headings from each of these articles, and add my comments. Based on your own circumstances, you can decide if it is time for owner financing for you.

Forbes

"That said, owner-financed homes can be complex and necessitate a written agreement—so it’s important to understand the process before signing on the dotted line.”

NoteSolutions

Whether a home is sold using owner financing or bank financing, a written agreement is required. So don’t conclude that this is a special concern of owner financing.

You may actually have more paperwork to review as part of bank financing. However both seller and buyer involved in owner financing, should be careful about the wording of documents offered by the other person. Whether your transaction is financed by the owner or by a bank, hire an attorney with the proper experience.

Forbes

“This can simplify the process of buying and selling a home by eliminating the need for a lender, appraisal and inspection.”

NoteSolutions

Certainly using owner financing can simplify the process of buying a home compared to getting a bank mortgage. However, establishing a fair price for the property is important for both the buyer and the seller.

From the seller’s perspective the adage “price or terms” may apply. This means that a seller hopes to get a higher price if offering favorable terms. Yet for the buyer who doesn’t qualify, or doesn’t want to qualify for bank financing, simply getting owner financing is important. Nevertheless, no one wants to settle for a bad deal.

So eliminating the need for an appraisal could be a bad idea. Online resources can be helpful to establish property values, but are not always accurate. Whether or not the transaction includes a balloon payment, the buyer might be refinancing using a bank mortgage in the future. Buyers should do their best to determine that the price they pay makes sense.

Likewise, should owner financing eliminate the need for an inspection? The buyer should consider this option based on the details of the property involved, and their ability to inspect it sufficiently themselves.

Forbes

“Just like a conventional mortgage, owner financing involves making a down payment on property and paying off the rest over time. That said, this alternative to traditional financing is typically more expensive and requires repayment or refinancing into a traditional loan in as little as five years.”

NoteSolutions

I think that there are too many factors that determine the value of a purchase, then to conclude owner financing is more expensive. Perhaps my thinking is partially influenced because I think of owner financing as also used to sell commercial property and businesses. Even for a home, you might find a motivated seller who offers a better deal than using bank financing.

Owner financing does not have to require repayment or refinancing into a traditional loan in as little as five years. There are really many ways to structure owner financing, especially when applied to commercial property and the sale of a business, in addition to residential property.

An initial consideration is how does the Dodd-Frank Act and/or the Safe Act apply to your situation? The Loan Origination Rule under Dodd-Frank applies to owner financing if the property secured by the loan will be secured by residential property. There are references made to a five year time frame. For more information refer to my article DODD-FRANK AND SAFE ACT CONSIDERATIONS, with additional helpful links.

Dodd-Frank does not apply to owner financing used in the sale of a business or commercial property. It also does not apply to residential property if the buyer is a limited liability company, corporation or partnership.

Depending on how considerations such as Dodd-Frank apply to you, could impact the use and terms of a balloon payment. Even without such legal restrictions, buyers and sellers need to be vigilant to how a balloon payment will affect them in the future. You are not forced to sign anything you don’t agree to.

As opposed to finding fault with owner financing as it applies to balloon payments, keep in mind that buyers who qualify, may be eager to refinance quickly. This is especially so if there is no prepayment penalty in the financing documentation.

Here Are Some Selected Advantages And Disadvantages From The Forbes Article:

Advantages for Buyers

“Eliminates down payment minimums imposed for government-backed mortgages.”

This is true and can be very helpful, as long as it meets the needs of the seller. I found it amusing though that in their Owner Financing Example, Forbes uses a down payment of 30% which is very high for residential property.

“Shortens the selling process by reducing due diligence requirements and eliminating the lending process.”

Certainly for buyers this can be another advantage compared to the bank financing process. However sellers need to do proper due diligence for their own benefit and in some cases to meet Dodd-Frank requirements. If you might sell the promissory note eventually, note buyers do expect that proper due diligence was done when the note was created.

Advantages for Sellers

“Still offers the ability to sell the promissory note to an investor for an up-front payment.“

This advantage follows what I said above. It shouldn’t be taken lightly that owner financing does offer this opportunity to property sellers. Here is some background on the topic at Would You Like Cash For Your Monthly Payments?

Disadvantages for Buyers

“May require borrowers to make a balloon payment at the end of the loan term.”

Buyers should prepare in advance to deal with the balloon payment. Ideally they have a clear understanding of these terms when they purchase the property.

Based on the way Forbes states this disadvantage, don’t get confused that the balloon payment is an extra payment beyond what you agreed to. You are paying the remainder of the note sooner, in order to get the benefit of a longer amortization term. Otherwise many sellers will not be willing to offer owner financing.

As I mentioned earlier, the buyer may decide to refinance before the balloon payment is due. While the balloon payment forces the issue to be dealt with, some buyers will choose to take action sooner then the balloon payment.

“Depending on the borrower’s creditworthiness, the seller may not be willing to provide owner financing.”

If you don’t qualify for owner financing then you wouldn’t qualify for bank financing. So this isn’t a disadvantage of owner financing. It would be a disadvantage to the seller to provide owner financing anyways.

“Seller’s mortgage may include a due-on-sale clause that requires them to pay off the mortgage upon selling the house, thus precluding them from offering owner financing.”

Whether you consider bank financing or owner financing, there are many reasons why buyers may not qualify. If a seller isn’t even offering owner financing, why is that a disadvantage to the buyer. If that is so, then every home that is not for sale would also be a disadvantage to prospective buyers.

How to Structure a Seller Financing Deal

2. Draft a Contract for Deed

“Also known as an installment sale or land contract, a contract for deed is when a buyer does not receive the deed to owner-financed property until he makes the final loan payment. Alternatively, the buyer receives title if he refinances the loan with another lender and pays the seller in full.”

Like with so many other topics, terminology can be confusing, and used in more than one way. According to the IRS an installment sale is a sale of property where you receive at least one payment after the tax year in which the sale occurs. An installment sale is one of the benefits of owner financing for the seller.

The term installment sale would also apply to structuring owner financing using a note and mortgage or deed of trust. For more information about installment sales refer to What Are The Tax Implications of Seller Financing?

Bankrate

Key takeaways

Bankrate

“Owner financing tends to benefit the seller more so than the buyer. It’s important for both parties to have an attorney establish and review the agreement.”

NoteSolutions

Keep in mind that owner financing can be used to sell residential property, commercial property, businesses, boats, cars and whatever else buyer and seller agree on. Of course many individual situations will apply, and owner financing can be of greater benefit to the buyer than the seller.

Seller financing can have excellent benefits for sellers. However, many sellers who offer seller financing don’t want to, but choose to do so out of necessity. So if you are a buyer reading the line above from Bankrate, don’t get discouraged thinking that owner financing is better for sellers.

Types of owner financing

On this topic Bankrate lists second mortgage, land contract, lease purchase, rent to own, and wraparound mortgage. It seems to be a serious omission to leave out first mortgages.

Pros and cons of owner financing

Bankrate

“Owner financing offers much more flexibility for both the buyer and seller, but it’s not without risks, particularly for the buyer.”

NoteSolutions

Another viewpoint would suggest that the risks are greater for the seller. The buyer faces the risks of home ownership whether they make their purchase using bank financing or owner financing. There are plenty of bank loan defaults, despite the greater underwriting scrutiny completed by banks.

The seller faces the risk of default on the owner financing. This could lead to the time and costs involved in foreclosure. By taking the property back, the seller takes on holding costs and potential rehab expenses to the property. Proper due diligence and using a loan servicing company to handle the note, can mitigate these risks.

Bankrate

“For a buyer, the main advantage is the ability to buy a home without needing to meet credit, down payment or other qualifying criteria.”

NoteSolutions

The buyer doesn’t need to meet the credit, down payment or other qualifying criteria of a bank. This is so either because they don’t qualify, or haven’t applied to a bank. The buyer does need to meet the credit, down payment and other qualifying criteria of the seller.

Earlier I mentioned the Dodd-Frank Act. Here is some of what I say in my article DODD-FRANK AND SAFE ACT CONSIDERATIONS about the seller’s underwriting criteria:

“By providing seller financing you are extending credit to your property buyers. There is a requirement that you determine the buyer's ability to repay the financing. While this rule is not a requirement if you qualify for the "one property exception," this approach should be part of any seller financing, and may be required as part of a simultaneous closing in order to sell the note. At a minimum, creditors generally must consider eight underwriting factors:

1. Current or reasonably expected income or assets

2. Current employment status

3. The monthly payment on the covered transaction

4. The monthly payment on any simultaneous loan(not to be confused with simultaneous closing)

5. The monthly payment for mortgage-related obligations

6. Current debt obligations, alimony, and child support

7. The monthly debt-to-income ratio or residual income

8. Credit history

Pros and cons for buyers

Pros

Bankrate

“No need to apply for a mortgage or undergo underwriting.”

NoteSolutions

My comments on the previous item apply again here.

Cons

Bankrate

“Responsible for keeping up with homeowners insurance and property tax payments.”

NoteSolutions

The buyer of a home is ultimately responsible for the payments of homeowners insurance and property taxes. The idea suggested by Bankrate is that with a bank mortgage the homeowners insurance and property tax payments are made by the bank. This happens because of the money the buyer pays into the escrow account.

The amount of money the buyer pays for homeowners insurance and taxes should be the same, with owner financing as with bank financing. The difference is that with owner financing the buyer will make payments directly to the insurance company and to the tax authorities. So Bankrate views this as a con.

Having a bank escrow account, will require a higher monthly payment, if all other terms of the financing are equal. Be prepared to deal with escrow adjustments in order for the bank to meet the amount required to have on hand based on Federal law.

So what can go wrong with the escrow process? Here is a personal experience. I did a cash out refinance mortgage. The new bank required that I pay the annual homeowners insurance premium in advance, which I did. After the bank received proof of the homeowners coverage, they also paid the annual homeowners premium.

Since this payment would be reflected as more money due in my escrow account, I needed to take action by contacting both the bank and the insurance company to get one of the payments back.

So the insurance company knew in advance that the following year’s premium would be paid by the bank from escrow. What happened on renewal? The insurance company sent me an email that my renewal premium is due. On the declarations page of my homeowners renewal policy, in small print, it stated “No Escrow.” Once again the homeowner, known as the buyer in this article is ultimately responsible for homeowners insurance and tax payments.

Pros and cons for sellers

Pros

Bankrate

“No need to negotiate offers or pay for repairs.”

NoteSolutions

This comment sounds like an assumption that based on the demand for a particular property, along with owner financing provided, means that the seller could stand firm on their asking price, irrespective of whether the property needs any repairs. That’s a lot to assume.

FAQ

“Who holds the deed in owner financing?"

Bankrate

Typically, the seller retains the deed until the buyer pays the owner financing in full.”

NoteSolutions

What is typical in one part of the country, may not be typical in another. The answer really depends on how the owner financing is structured. A distinction between legal title and equitable title may apply. Use an attorney to clarify what applies in your situation.

Business Insider

“In general, sellers can only offer financing if they own their home outright, with no existing mortgages or loans on the property. Otherwise, they'd need approval from their lender first.”

If you have an existing mortgage on your home, you do need to understand your note and mortgage when you consider moving on. But if you plan to sell your home, and pay off an existing mortgage, you do not need the bank’s permission first, to use owner financing.

The Agreement Process

“If the seller is still paying off their current mortgage, the financing might be structured as a "wraparound" loan, where the seller maintains the buyer's mortgage on top of their own.”

Here is my definition of a Wraparound Mortgage:

“A Wrap Around Mortgage, also known as an All Inclusive Trust Deed (AITD), is a form of financing in which a new promissory note equal to the purchase price of an asset, minus the down payment, wraps or includes an existing loan. The funds paid on the wrap around mortgage are used to pay the existing loan, while also paying the remainder of the purchase price to the seller.”

This description comes from my article Should You Use A Wraparound Mortgage? which I encourage you to read.

Is seller financing a good idea?

“Seller financing can be advantageous for buyers who don't qualify for traditional financing, or for sellers who want to start earning investment income. But there are risks as well, and it can be more expensive than traditional financing.”

This answer from Business Insider seems like a good three line answer. But if you lack background in owner financing, just reading this answer could leave you confused, or thinking that it gives you a good enough summary. The possibilities go way beyond this answer.

Below are additional resources for you to expand your outlook of owner financing. Then I encourage you to use your creative imaginations, and utilize owner financing as often as the time is right for you!

Additional Resources

Top Photo By Jon Tyson On Unsplash