Published on Monday, February 15, 2016 by Land Century
What is Owner Financing? How Does It Work?
Simply put, owner financing is when the buyer finances the purchase of a property directly through the seller. This type of financing is common in the land market, as it can be very difficult to obtain a conventional loan through a bank.
If you dont have cash in hand and the buyer is looking to get rid of the property quickly, owner financing may be negotiable. In some cases, part of the financing may be through the owner, and a small portion will be covered by a bank loan.
The great thing about owner financing is that nearly all terms are negotiable, including the interest rate, repayment term, payment amount and the amount financed. Typically, rates are higher than conventional loans, but there are no loan fees incurred.
How Owner Financing Works
Typically, payments are made directly to the seller, but some owners will use a collection company to collect payments. The transaction is similar to a bank loan, but without the fees. Youll be required to sign the same documents to transfer the property to your name and to secure the loan itself. The only difference here is that the lender is the seller not a bank.
A few of the documents involved in the transaction include:
* A Warranty Deed: This ensures that the buyer owners the property.
* A Trust Deed and Trust Deed Note: These two documents are required to secure the loan. The Trust Deed will be recorded with the Deed Warranty, and will include the loans total amount. The Trust Deed Note will not be recorded, but will include the terms of the loan, such as the payment date, payment amount and the interest rate.
Its important to note that the Trust Deed can actually be foreclosed on if you default on your loan. Typically, this is a lengthy 3-4 month process (although it can vary from state to state), and will not require a court hearing.
From a buyers perspective, there are numerous benefits to owner financing when buying land:
Easier to Obtain
Because youll be working directly with the seller and not the bank youll have an easier time securing financing. Sure, the seller will (hopefully) do his or her homework to make sure that youre a reliable borrower, but generally, there isnt a lot of red tape involved. And if your credit isnt great but you can demonstrate that you have the means to repay the loan, the seller may be able to look past your credit history.
Everything is Negotiable
Unlike a bank loan, all terms are negotiable when financing through a seller. This includes the interest rate, payment amount, the length of the repayment term and how youll make your payments.
Because the loan is not subject to bank approval, the closing process can move along very quickly. This means that you can start using the land in just a few weeks, rather than waiting months for a typical closing.
No Loan Costs
With a conventional loan, borrowers incur a number of a fees, including origination fees, points, underwriting fees, credit reports, appraisals and title insurance. While they may seem miniscule, these fees can add thousands of dollars to the closing costs. When financing directly through the seller, you can avoid having to pay these fees.
Naturally, there are some disadvantages to owner financing, too:
Higher Interest Rates
Although you wont be paying loan costs, you will likely pay a higher interest rate. In some cases, the higher rate winds up making the loan cost equivalent to (or more than) a typical bank loan.
No Credit Score Improvements
If youre financing through the seller, theres a good chance that he or she will not report your timely payments to the credit bureaus, which means that the loan may not necessarily improve your credit score.
Its not uncommon for larger owner financed loans to require a balloon payment after five years. If youre looking to purchase a large parcel of land with a high price tag, you need to ensure that youll be able to secure a conventional loan within this timeframe. Otherwise, youll be responsible for paying a large bill at the end of the five-year period.
Seller Still Needs to Approve
While the seller probably wont be as stringent as a bank in terms of your credit score, he or she will still need to approve of the loan. A seller may be interested in owner financing, but that doesnt necessarily mean that he wants to be your lender.
The Bottom Line
Owner financing can benefit both buyers and sellers. It allows the seller to get the property off of the market quickly, and the buyer to obtain the property without having to pay in cash. In the land market, its difficult to secure a conventional loan, so owner financing is typically up for negotiation with most properties. But its important to keep in mind that you may wind up paying a much higher rate, and the seller will still need to approve the loan. With that said, closings are quick, all terms are negotiable and you can save money on loan costs.
Ultimately, if you want a piece of land and dont have the cash for it, inquiring about owner financing is a smart decision. Just ensure that you get all of the terms of the agreement in writing, and that the owner presents a Warranty Deed to prove that he or she owns the land free and clear. If you can agree on the terms and the seller can prove ownership, you may be well on your way to closing a deal and enjoying your new property.