Owner Financing: Pros and Cons for Buyers

Owner financing can be an alternative source of funding when buying a house.  It may be a way for a homebuyer to purchase property for which he is not financially qualified (fully or in part) by traditional lending institutions.  But, if a buyer is not qualified for a loan, there has to be a reason a seller is motivated to take on the role of his mortgagee (lender).

Why isn’t the property attracting buyers?  —Well, it could be that tight funding has limited the number of buyers.  It could be that the property is overpriced or in poor condition.  (So, no interested, qualified buyers.)  Or, it could be that everything is fine and this owner wants a long-term income.  Regardless the owner’s reason, if you are considering this type of financing, you—the buyer—need to research the property for suitability and then decide if a private arrangement will work for you.

Here are some things to consider—both pros and cons.

I’ve already mentioned that the seller might be asking an exorbitant price for the property, perhaps relative to its location or condition.   (Note: It might not be you, but rather the property, that disqualifies traditional financing.)  Also, the owner may require a large down payment.  Or, the interest rate may be higher than that of a conventional mortgage.  (That may be the seller’s way of getting an equivalent to money that lending institutions charge as fees associated with mortgage loans.)  Monthly payments may be high. And often, owner financing is short-term (possibly, a few years) with a balloon payment due at the end of the contract.  Many buyers must be prepared to refinance.  (At that point their financial profile and the property must be conducive to qualifying for a traditional mortgage.)

With reference to the above:  In my last post I said that owner financing could be useful to a potential buyer with a less than desirable financial history—a history making him unlikely to qualify for conventional funding.  “History” is key here.  Entering into a sensitive financial contract, like a mortgage, while in the throes personal economic crisis (and given this type of financing, it is occasionally possible to do so) promotes disaster.  Homeowners always encounter unforeseen circumstances requiring the outlay of money—financial stability is imperative.

One risk deserves great consideration:  There are some forms of seller financing in which the seller remains financially responsible to a lending institution for the property. (Wrap, combo financing and, possibly, option financing are among these.) You—the buyer—make payments to the seller and he makes his mortgage payments.  But what happens if he doesn’t?  If he defaults, you could lose the property and everything you have invested in it.

A buyer does need to protect himself as much as possible.  As with other major financial commitments, it is wise to have a legal representative advising you as the terms of the contract are determined.  Most sellers do.

There are also a number of positives for the buyer to consider.  Right away you’ll notice that a few seem to be (almost) the flip-side to some of the issues requiring cautious regard.  —Many aspects of this financing have to do with the seller’s motivation.  Some sellers are actually predatory.  They find buyer after buyer who will not be able to sustain the contract and so, repossess and resell their property a number of times.  These people are unscrupulous, but as you are dealing in a private sector—owner financing— there are few regulations to enforce ethics.  Thankfully, most owners are interested in a successful sale.

If you are dealing with a well-motivated seller, you may be able to purchase a desired property for which a lending institution won’t qualify you.  (The issue of qualifying is complex.  Above, I said that sometimes the price, condition, or location of the property prohibits qualifying.  As another example:  Your finances may be quite sound.  Even so, because you recently married, divorced, changed jobs—and the list goes on—banks may refuse to qualify you for a mortgage loan; they don’t like change.)

Negotiations with the seller eliminate the need to shop around for the best deal.  This and other aspects can save some time:  Conventional lenders often take awhile to have the property researched for a clear title.  You can do this yourself and save time.  (Again, you would be wise to have knowledgeable legal counsel to guide you.)  Dealing directly with the seller may be speed up closing—and moving in before closing may not be an issue.

With owner financing you will avoid many of the fees associated with a mortgage from a conventional lender.   It’s also likely you will have considerably more input on the terms of the contract.  Down payment, interest rate, monthly payments, duration of the loan, even a resale clause are among the terms that can be negotiated.  Some of these can result in significant liberties and savings:  A private seller is not bound by “company policy” nor tied to a financial index.  You may even find a seller who is willing give you a discount should you do an early payoff.  (Banks frequently charge a fee for this.)

Most sellers doing private financing are not credit bureau subscribers.  (Subscription fees are quite high.)  This means they cannot make as comprehensive a check into your finances and personal history as a bank; you will be able to maintain a greater level of privacy.  They may, however, ask you for references and to provide a copy of your financial report.  Another aspect of this is that your payments will not be reported:  Owner financing will do little to help you build a positive financial profile.  On the other hand, should you encounter financial hardship during the course of your contract, a motivated seller might be more responsive than a bank to concessions and renegotiation.  And again, it would be a private matter and at least mitigate the effect on your credit standing.

It is important to be financially prepared to buy a house.  It is also important to realize that finances are not the only factor involved when qualifying for a mortgage.  —And, to realize that not qualifying does not mean financing is not available.  Owner financing is not common.  But with patience and persistence, it’s possible you will find a suitable property and a motivated seller.