In this tight credit market, you may have difficulty qualifying for a mortgage with less than stellar credit and limited down payment money. If you have located the house you want to buy but cannot go the traditional mortgage route, you may want to explore direct financing from the current owner for these reasons.
- No Rigid Qualifications – You do not have to convince a bank of your creditworthiness; you have to convince the homeowner. That does not necessarily mean it will be easier, but at least you have a chance to make your case.
- Creativity in Terms – You are not restricted by down payment rules, strict payment terms, etc. Terms are whatever you can negotiate.
- Streamlined Process – Without a bank in the loop, you can close faster and generally with lower costs.
It seems like a win-win situation – the owner receives money and you receive the house without a bank in the middle. However, owner financing contains risk for both the buyer and the seller. Ask yourself these questions.
- Why Owner Financing? – If somebody is willing to owner finance without you initiating the idea, he or she is doing so for a good reason. You should not be afraid to ask why. Perhaps there is a buyer’s market and they are willing to accommodate you just to sell the house, but there could be other reasons.
Is it a financial issue where the seller would rather have regular income than a lump sum? Is the home overvalued? Is it a fixer-upper beyond traditional mortgages? Is the title unclear and ownership in question? Be skeptical if you cannot see the reasoning behind the owner financing.
- Is There An Existing Mortgage? – If the seller still owes a portion of the mortgage, owner financing is tricky and potentially dangerous.
Consider the way a traditional mortgage works – the bank pays off any remaining portion of the mortgage with your new mortgage, and the seller pockets the difference. To discourage owner financing (among other reasons), almost all mortgages have a “due on sale” clause, meaning that the bank has the right to demand full payment of the mortgage upon sale.
Unless your down payment covers the remaining amount on the original mortgage, this leaves both you and the seller vulnerable since the bank has the power to foreclose.
The bank may not invoke that clause or even care…but should they invoke it, both buyer and seller could be shut out.
Why take the risk? Stick with homes that are free of debt if possible, or that clearly have assumable mortgages – where you take the seller’s place with the approval of the bank.
If you and the seller are willing to proceed and agree on terms, you will both sign a promissory note containing the terms of the agreement, and then mortgage paperwork must be filed with your local public records office. It is important to retain an experienced real estate attorney or similar professional to draw up the necessary contracts and paperwork
Owner financing can take several forms beyond the assumable mortgage and partial mortgage listed above. Here are a few of the common ones.
- All-Inclusive – Similar to the bank process, the seller holds the entire mortgage amount (minus any down payment) and the promissory note. The buyer makes mortgage payments plus interest directly to the seller.
These arrangements can be short-term – amortized over a typically long term but with a balloon payment in a shorter time (5-10 years). You may want to switch to a traditional bank loan in that time frame, and the seller may want to receive the entire home price in less time than a traditional 30-year mortgage.
- Lease Option – The contract is established as a lease, with an option to buy from the seller under certain terms within a given time. This allows a “trial period” of sorts, and allows for a discount at sale based on the lease money already paid.
- Land Contract – In a land contract, the seller establishes co-ownership (“equitable title”) and the deed is transferred upon the final payment. This gives the seller a further level of security.
- Secondary Mortgage – You can bring the banks back into the process by convincing the seller to assume a lesser mortgage (also known as a secondary or junior mortgage) on the house to bridge the gap in your traditional bank financing. However, this contains more risk for both the bank and the seller and may be difficult to achieve in today’s market.
With proper research and negotiating skills, you may be able to acquire owner financing and meet your home-ownership goals. If not, you can always keep saving and improving your creditworthiness until you can buy a home through more traditional means.