Owner financing can be an alternative to a bank loan when you are buying a house. Even when mortgage money is tight—either because of a falling economy or because of a poor credit history—there are owners who are willing to “carry back” a part of the purchase price to facilitate the sale of their property.
The term “owner or seller carryback” refers to the seller of a property being willing to finance (in part or whole) the purchase price of the offered property. Typically, this is not a monetary loan. Also, in some of these arrangements, the seller does not receive full payment at once—but the property is his security. Instead, the seller extends credit to the buyer and is paid back with interest. Both parties sign a promissory note stating the sales agreement and payment terms; many terms of these can be negotiated, including down payment, interest rate, and length of contract. Then, the agreement has to be filed with public records—usually as a trust deed, mortgage, or land contract.
A seller can be involved with financing either pre or post closing. There are 8 common forms of owner financing. Four involve a financial accord after closing and four before closing.
Post-closing types include:
Free and Clear Financing: If the seller owns the property free of any encumbrances (no mortgage or other liens), the buyer and seller negotiate all terms.
Equity Only Financing: When there is a mortgage or other lien in place against the property, the seller may not be free to finance anything but his own equity. In this case the buyer must pay off the seller’s outstanding balance(s) at closing—usually by obtaining new financing.
Wrap Financing: Sometimes, when the seller is still involved with a lending institution, he is allowed to do what amounts to passing along funds from the buyer. In this case the buyer makes payments to the seller. The seller (who might not have much equity in the property) remains responsible to pay his financial obligation on the property—usually a lesser amount than that received from the buyer. The seller seems to continue to build equity in the property, but just as he passes payment to his mortgagee, the equity (essentially) passes to the buyer. This type of financing is also known as “blanket,” “issue to,” or “subject to.”
Combo Seller Financing: If the seller has some amount of equity, but is still encumbered, he may generate what amounts to two loans to the buyer. One loan finances the equity purchase, the other is wrap financing. The terms (interest rates, payment schedule, duration, etc.) of each loan would be independent of the other. Literally, this is a combination of equity only financing and wrap financing
The following four types of owner financing are in effect prior to closing:
Purchase Option: In this form of owner financing the buyer and seller have an agreement (usually accompanied by an “option fee,” paid by the buyer) that locks in the purchase price—sometimes discounted—for a designated period of time. If within that time period the buyer does not go through with the purchase, he is released from any obligation to buy (but the option fee is not refunded). In the interim the seller remains financially responsible in full for the property. Buyers, who have not prearranged funding, often find the Purchase Option useful. —The “Rent to Own” arrangement is a well-known form of the Purchase Option.
Extended Closing: This is similar to a purchase option, but more terms of the sale may be defined—one of them being an extended deadline for closing. (Frequently, this gives the buyer time to sell a piece of property or terminate a lease.) The arrangement is formalized with a Real Estate Purchase Contract. Often a fee (basically, “Earnest Money”) is required of the buyer. If this is the case, under certain circumstances, detailed in the REPC, that fee can be refunded if the sale does not go through.
Open–ended Closing: This type of owner financing also involves a Real Estate Purchase Contract. One of the terms on which the closing depends is a future event—often, something for which the seller is responsible—like the completion of a remodeling project.
Seller Partnerships: In this arrangement “sweat equity” on the part of the buyer is an essential component. Depending on the terms of the contract the seller may or may not actually transfer ownership to the buyer. Either way, he retains financial interest in the property. As in any partnership both parties contribute: The seller contributes the property and possibly funds to improve it. The buyer might also contribute financially, but his major role is to do “clean up/fix up”—to enhance the value and salability. The buyer then refinances or sells the property. At the closing the original owner receives his equity payment and is reimbursed for any capital contributed. Profit is split according to the terms of the partnership agreement.
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