What is Owner Financing?
Owner financing (OF) is pretty simple. It’s when the guy who sells you the object or service takes his money over time (monthly) rather than as lumpsum cash. Do you need some expensive mouthwork? Look around and find a dental office which will let you pay them over time for all that rootcanaling and crowning. Gotta have a new refrigerator? Yeah, you might have to apply for a Sear’s credit card so you can keep your milk from spoiling while you pay for the thing.
In the case of real estate (RE), the owner functions as both seller and lender, and just like a bank, she won’t trust her buyer’s word on the loan but will place a mortgage/lien on the property which she is selling. If the buyer doesn’t pay as agreed, she’ll go through a process to recover the RE. Foreclosure is a common name for that process. Repossession. In virtually all cases of OF, the seller will get something extra from the buyer for financing her item. It might be a higher price. It might be interest on the unpaid balance. It might be both.
As usual in capitalism, those without capital (poor folks) have to pay more. But don’t be mad at the seller.
Money is time and time is money. She deserves 1) her price and 2) whatever a third-party lender would make if the buyer used them for the financing, rather than using the seller for it. With RE, the owner-financing seller will generally make the buyer sign a promissory note (an IOU secured by a mortgage or deed of trust) which will spell out all the terms of the financing:
APR… or interest rate.
Term… or how long the loan is spread out or amortized.
Payments… by the week, the month, the quarter, etc. How much, etc.
Default… including what triggers it, like failure to pay on time or failure to cover the property with insurance, etc.
Due on Sale Clause… or whether a new buyer can assume the OF loan.
And other terms. Before we go on, let me advise again that you always use a lawyer with any and every real estate transaction, but perhaps even moreso with ownerfinanced deals.
There may be some federal laws which are pertinent, along with individual state laws, so let the professionals guide you.
What’s So Great About Buying with Owner Financing
No Money Needed
You don’t need a bunch of money to buy real estate (RE). Not if you bargain for owner financing and especially for a low downpayment. Under the right conditions, it’s even possible to buy RE without any money at all up front. One time we bought a group of duplexes which were so run down that the tired old owner just wanted out. We walked away from that closing with 40 rental units and about $4,000 cash. That’s because he sold to us with nothing down AND gave us all the escrowed rental deposits at closing. (40 units X $100/unit security deposits.)
And our rental income paid the monthly note on those places. We had to fight for it, as we worked our fingers to the bone and ruined our backs, gradually improving the units and raising the rent, but I can’t remember that we ever had to reach into our own pockets on that deal.
Which was a good thing, considering the condition of our pockets at the time.
Anyway, although this is an extreme example, it is very much true that you can buy RE with little or no money down, by asking the owner to finance the sale.
No Credit Needed
So far as I know, the old man never even checked our credit. He did ask us
for financial statements but, as I say, he was desperate to sell and must not have had very high standards when financing properties. Over the years, no seller has ever again asked me for a financial statement. Not even for my social security number to run my credit. Who knows why.
Maybe because they can tell that I’m pretty professional and presumably substantial. Maybe because they don’t mind if I fail and they get the property back. Or maybe it’s just because they want to be done with the sale, so they can move on to other things. I don’t know. But I know that even if I had terrible credit, none of those seller-lenders would have caught me. Bad credit would not have killed any of my Owner Financing deals. If you have credit problems or maybe you are self employed, without the ability to prove your income through traditional documentation, ask for Owner Financing.
Maybe you’ve got a bankruptcy which won’t scroll off your credit report for another two years. Ask for OF. Not to say that a seller-lender will not run you though the credit wringer, especially on a single-family residential property. He very well might. But not usually with the vigor of an institutional lender, and he might go ahead with the loan anyway, especially with a larger downpayment or by using one of the non-deeding techniques.
No Underwriting and Bank Fees
If you’ve ever bought a property with traditional bank financing, you have my condolences – especially if you are a divorced woman. I once sat through a closing where a thrice-divorced woman had to tediously sign all five of her names, again and again, on dozens of documents. Most all of them were the mortgage papers, the bank papers. And that’s just the hassle part of it. There’s also the money part of it. A mortgage lender will comb through every detail of your life and of the property and then make you pay for its underwriting efforts, plus various other fees.
Origination fees, loan points, credit report, flood certificate, mortgagee title insurance, credit report on spouse and dog, tax certificate, appraisal fee, PMI, etc.
I’ve read that closing costs for traditionally-financed homes run between 2% and 5%. So buying a $200,000 home could cost you as much as $10,000 in closing fees.
But if you bought the same home with OF? Maybe as little as $500, if you just need the title search and the doc prep. A bit over $1,000 if you’re wanting title insurance.
Let’s say you’ve found a property which you believe to be a most excellent deal. So good that you’re worried you might lose it before closing.
A traditional bank loan could take 6 -8 weeks to close. Even longer if some minor issue comes up. A septic system in need of pumping out and recertifying.
A glitch in the survey requiring negotiation with a neighbor. What to do? Well, you could just propose owner financing to the seller.
Offer a large downpayment or maybe a balloon payoff.
Whatever you need to do to convince him. You can now close within days, maybe within hours. All you need is a clean title and the proper docs prepared.
If you need to make a loan against the property later, after you own it, you could still do that and pay off your seller-lender early.
So you’ve found these three great houses. They’re side by side, just around the corner from your home, and belong to a doctor who lives in Timbuktu. The no-good renters have trashed the places and recently moved out in the middle of the night. You’ve talked to the doctor, and he really wants to sell. ASAP.
Because you are handy and have an account down at the hardware store, you are certain that you can buy these houses, fix them up, and make a really big pile of money, either on a flip or by renting them out. The problem? Well, you’re stretched out. Your banker is a little worried about you and will only make you a loan on one house… with a $15,000 downpayment.
Damn! If only I could buy all three houses! It’s my shot at the big time! Right here, on this one deal! If only I could – Oh, calm down. And think about it. Have you forgotten about OF? Call the doctor. Convince him to take $15,000 as downpayment on the three houses and then to receive regular monthly payments from you.
Leverage your money. Use owner financing to buy all three houses. OF is a great way to leverage yourself into bigger deals. More deals. But wait. Is your banker right? Is it dangerous for you to do that – to leverage yourself out that way, beyond what he considers to be prudent? Sure it can be. You betcha. Just ask anyone who got caught RE-heavy by the Great Recession. Can you get rich as a RE operator without doing that? Nah… not so much. By the way, private seller-lenders almost never report your loan to the credit bureau. If you are happy to hear that, well, great. Use it as you see fit. If you’re sad about it, because you want to build your credit, ask your sellerlender to please report your timely payments and help him figure out how to do that.