Having Trouble Selling Your Home? Consider Owner Financing

The majority of potential homebuyers today don't have trouble finding a home that they like-the issues come when trying to finance the home.

That is where you, the seller, come in. To set yourself apart from others trying to unload their properties, consider offering owner financing. Given the proper circumstances, owner financing can be extremely helpful in bringing buyers and sellers together for a successful real estate deal.

What Exactly Is Owner Financing?

The home sales term "owner financing," also called "seller financing," means the seller helps finance the buyer's purchase by loaning the buyer part of the seller's equity, instead of receiving all cash from the buyer at the time of sale. Seller financing does not mean the seller takes out an additional mortgage before selling. To assist with the structuring of an owner-financed transaction, consult a knowledgeable real estate agent.

So How Does It Work?

When owner financing is offered as a first mortgage, meaning the seller acts as the buyer's only mortgage lender, the seller provides financing for the full amount of the purchase or the full amount less a down payment.

In a situation of a seller-financed second mortgage, the buyer obtains a bank mortgage for a portion of the purchase amount, and arranges a seller-financed second mortgage to cover the balance. Under this arrangement, the seller receives the first mortgage portion of the sale proceeds immediately, but the seller also accepts a lower priority lien on the second mortgage amount. If the borrower defaults and the house must be sold, the seller is only repaid after the first mortgage lender is repaid.

Types of Owner Financing

Purchase Money Mortgages

This is basically a promissory note (an IOU) to the seller. A financing instrument (mortgage or deed of trust) is recorded with the county Register of Deeds.

Land Contracts

Land contracts do not pass legal title to the buyer, but give the buyer equitable title, meaning the buyer has a right to obtain absolute ownership to a property even when legal title is held in another's name. The buyer makes payments to the seller for an agreed-upon period and upon final payment, the buyer receives the deed.

Land contracts can be structured in a number of ways-an installment sale land contract, an all-inclusive (wrap-around) contract, or a straight contract.

Lease-Purchase Agreements

With lease purchase arrangements, the buyer and seller negotiate a property lease for a specified term. As part of the agreement, the buyer must purchase the home for a stated price, within a certain time frame. An upfront payment may be made to the seller. Normally, some portion of the monthly lease payments are applied to the purchase price of the home. During the lease term, which can be several years, the buyer must seek out lender financing. Once that is secured, the buyer pays off the seller and completes the sale.

If the buyer does not abide by the terms of the lease-purchase agreement (i.e. he or she does not secure financing within the term specified in the arrangement or he or she defaults on the monthly payments), the buyer can lose all funds invested in the property.

Benefits of Seller Financing

For Sellers

Less time on market/Sellers are able to attract more buyers.

Owner financing allows sellers to be more flexible in the loan terms, which attract many more buyers that aren't able to obtain financing from a bank. This allows you to sell your home quicker and begin recouping selling costs sooner.

Owner financing offers some tax benefits.

Under the installment method of reporting gain in a taxable transaction, a taxpayer who receives payments from a qualified installment sale (which in most cases includes seller-financed properties) is allowed to recognize a percentage of the taxpayer's gain as each payment is received, rather than being required to recognize the entire taxable gain in the year of the sale.

Because the taxpayer recognizes the gain over the taxable years in which the payments are actually received, the taxpayer is able to defer payment of income taxes that are assessed on that gain.

Sellers are able to charge an above-market interest rate for the loan.

Sellers are typically not in the business of financing. If the buyers could go out and get a loan from a normal lender at market rate, they would. Therefore, the seller should be compensated for the risk they are taking by charging a rate slightly higher than the market rate for a comparable loan.

For Buyers

Buyer does not have to qualify with a loan underwriter.

Opting for seller-financed property allows the buyer to have more flexible criteria for obtaining the loan, as opposed to going through a loan underwriter at a bank, which has more stringent criteria. While some sellers who offer financing may require a credit report, those sellers usually don't review it as critically as a loan underwriter would.

Closing costs will be lower.

A significant portion of a buyer's closing costs includes origination and processing fees from the bank. With no bank involved, these costs are gone. In addition, banks usually require anywhere from one month to six months of reserves for taxes and insurance. Sellers who provide financing usually do not require these prepaid expenses.

No mortgage insurance (Private Mortgage Insurance-PMI-or Mortgage Insurance Premium-MIP).

This basically amounts to a lower mortgage payment for the buyer!

For Both Parties

Flexible loan terms.

With owner financing, a loan can be structured in any way that makes both parties happy. Here are examples of loan terms that can be included in a seller-financed note:

Buyer will pay seller monthly interest payments of $xxx.xx and quarterly principal payments of $xxx.xx.

The interest rate on the note will be 6.25% for years 1 and 2, and increase by 0.50% each subsequent year on the anniversary date of the note.

Buyer will pay seller a lump sum of $xxxx.xx annually.

Buyer shall have the option to prepay the note at any time without penalty.

Buyer shall have the option to prepay the note at any time; however, a prepayment penalty of $1,000 will be assessed to the balance of the loan.

The possibilities are endless, which is one of the great things about owner financing. The actual mortgage payment can be as flexible as the buyer and seller would like. As long as both parties agree to the terms, and the terms are in writing, it can be done.

Challenges/Risks Involved

For the Seller

Seller must receive cash in monthly installments as opposed to a lump sum.

Instead of receiving a lump sum at closing if a buyer were to obtain financing from a third party like a financial institution, sellers who provide financing must receive monthly installments over a number of years.

Buyer may default on note; seller has to foreclose.

As with banks that repossess properties, it can be very expensive for a seller to foreclose on a property on which the buyer has defaulted. Between attorney fees, paying off any additional liens the buyer may have had placed on the property, and repairing any damages made by the buyer in order to market the property again, repossession can be quite costly for the seller.

For the Buyer

Buyer may have to put down a larger down payment than with a bank.

Obviously, a seller wants to be protected when offering financing for a home. If a buyer is seeking owner financing because he or she is unable to obtain a bank loan, this is a red flag to the seller that there may be some financial or credit issues involved. Therefore, to ensure the buyer has a vested interest in the property, the seller may require a down payment of 20% or more to secure financing. However, down payments (as well as the other loan terms) are negotiable between the buyer and the seller.

The buyer could pay the loan in full but still not receive title to the property.

This can occur due to other encumbrances not divulged by or unknown to the seller.

The buyer may make timely loan payments, but the seller could default on senior financing on the property, thus subjecting the property to foreclosure.

Just like renters who are being evicted because their landlords have not paid the mortgage, the same could happen in a case where the seller financing is a junior lien on the property.

The Bottom Line

At the end of the day, a seller-financed transaction can be beneficial, as long as it meets the needs of-and is satisfactory to-both parties. With a proper "meeting of the minds", owner financing can certainly be a win-win situation for all parties involved.