How Does Owner Financing Work In Real Estate?

How Does Owner Financing Work In Real Estate?

How Does Owner Financing Work In Real Estate?
Whether you’re looking to invest in real estate or purchase a new home, there’s a good chance you’ve considered owner financing. Although not as common as a traditional bank mortgage, seller financing is still a viable option for some buyers. Not sure how the process works? We’ll explain how owner financing works in real estate to help you decide if this is the right option for you.

What Is Owner Financing?

Owner financing is exactly as it sounds – instead of a buyer getting a mortgage from a bank, the owner will finance the purchase.

Just like with a traditional loan, a promissory note will be drawn up by the buyer and seller that outlines the repayment schedule, interest rate and the consequences of defaulting on the loan.

In essence, the owner of the property takes the place of a bank. The buyer will send monthly payments to the owner, and the owner will collect interest on the loan. The owner also has the option of selling the loan. In this case, the buyer would then begin sending monthly payments to the investor(s) who purchased the loan.

Seller financing is typically short-term (five years or less). At the end of the loan term, a balloon payment is due. The idea here is not to keep the seller on the hook for duration of a traditional mortgage (15-30 years), but to give the buyer a chance to buy the property now and refinance before the repayment term is up.

Owner and Seller Financing Difference

You may hear the terms “owner financing” or “seller financing” used when talking about this unconventional lending method. Don’t let these terms confuse you. Both refer to the same thing, and can be used interchangeably.

Why Owner Financing in Real Estate is Uncommon

Owner financing is uncommon, but not unheard of in real estate. This unconventional lending method tends to be common if mortgages are hard to come by.

If mortgages aren’t difficult to obtain, but a seller can’t get one, this may be an indication that the buyer isn’t in a financial situation to repay a mortgage. However, if mortgages aren’t easy to come by, even well-qualified buyers may have a hard time securing financing. In this case, sellers may be willing to take an unconventional approach if it means they can sell their property.

Sellers are also more open to unconventional options when credit is tight and selling property becomes a challenge.

But another reason why more sellers aren’t interested in financing the purchase is because they really don’t understand how the process works and they assume they can’t afford to lend the buyer money. In many cases, sellers rely on the proceeds from the sale to buy a new home. Most don’t realize that they can actually sell the loan to an investor for cash – and they can sell the same day as the closing if they want.

What About Owner Financed Land?

When it comes to real estate, owner financing land may be unconventional. But when it comes to land, sellers are more willing to finance a buyer’s purchase. Why? There are many reasons:

- In most cases, the land is strictly an investment. And because it’s undeveloped, the seller probably won’t be using the proceeds to buy a new home to live in. Chances are, they’d be using the proceeds to make another investment.

- In many ways, seller financing is still a form of an investment as the owner will receive interest on the loan.

- Mortgages aren’t always easy to come by when buying land. Sellers understand this, and are more willing to work with buyers to finance their purchase.

Purchasing land by owner financing is undoubtedly much easier to do than purchasing a home by owner financing. In fact, you’ll find hundreds of parcels for sale all over the country that are owner financed.

The Advantages of Seller Financing For Buyers

From a buyer’s standpoint, there are many advantages to seller financing:

- Closing costs may be lower. Because you’re not dealing with the bank, you can avoid having to pay appraisal costs and bank fees. This greatly reduces the closing costs, which means buyers can purchase the property for less.

- The down payment may be lower than the mandated minimum. Because you’re dealing directly with the seller, the down payment can be whatever you and the seller agree to. Note: While there’s a chance the seller may negotiate the down payment, don’t expect them to. Many sellers still expect buyers to put 10% down.

- The closing process is much quicker. There’s no need to wait for the legal department, underwriter and loan officer of the bank to clear a file, so closings can happen quickly with owner financing.

Seller financing allows owners to finance the buyer’s purchase and earn some interest from the loan. Although not common in real estate, owner financing is more readily available when selling land as mortgages are difficult to obtain. This unconventional financing method allows buyers to get into properties quickly, and sellers to minimize carrying costs.

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