What is an Owner Financed Home Loan?
Owner financing is where the current homeowner becomes the lender to a buyer purchasing land or a land and home together. As with all forms of financing, there are pros and cons to owner financing.
When Does Owner Financing Make Sense?
Owner financing is often more about the seller than the buyer. The top concern tends to be whether the seller is willing and able to handle a default on the loan. If the seller is willing to handle the risk, then there are a couple of common situations a seller would choose to owner finance their land or home.
The first reason is a potential buyer is not able to acquire a regular loan for the property. If the seller feels the risk is worth it, the seller has freedom to sell to folks who can’t obtain a loan elsewhere. The benefit to the seller is they can sell the home more quickly or sell to a buyer they know and like.
Another reason to choose owner financing is the seller can choose to provide a lower interest rate than the bank. You see this situation more often when property is sold within a family. For example, Grandpa and Grandma sell a couple of acres of their farm to one of their grandkids and they would like to gift the grandchild with a “free loan,” meaning they will make payments for the exact amount of the sale with no or little extra for interest.
What is Great About Owner Financing?
With owner financing, it can be a lot easier and faster to transfer ownership of a piece of property. It may also be the only way a person seen as “high credit risk” can buy property with a low down-payment. For the seller, they can also make a little more money by earning interest on the loan, though it would depend on the buyer not defaulting on the loan.
Owner financing can also be a very generous gift to a friend or family member when there are no or super-low interest rates on the loan. It feels good to save a family member a lot of money with an interest free loan.
What are the Dangers of Owner Financing?
Loan contracts can have a lot of “gotchas” hidden in the details. It is easy to understand the monthly payments and how long the payments will go for, but the dangers are in the details.
First and foremost, when entering into an owner finance situation as a buyer, use a title company or attorney. They will ensure all the documentation is legal and that the deed is “clean,” meaning the seller actually has the right to make the sale, there are no tax liens from unpaid property taxes, and there are no other parties on the deed that need to sign off on the sale.
Make sure you have a lawyer on your side review the documents and have the lawyer help you understand any key details you may overlook through the legal jargon. What happens if there is a missed payment? Is a certain level of insurance required for the property? Only an attorney will be able to safeguard you from a one-sided loan agreement.
Since there is often more risk on the part of the seller, the interest rate on the loan is usually higher than if a bank loan was taken (excluding those “family free loans” we mentioned above).
A lot of owner-financed loans are only for a short period of time with a “balloon payment” due after just a few short years. They are setup so you make loan payments as if you had a 20 or 30-year loan, but the full balance is typically due at the 5-year mark.
The hope is that the payments of principal and the appreciation of the home will be enough of a “down payment” to get a bank loan…but what happens if you can’t get a bank loan when the final payment is due? People get laid-off from their jobs, housing markets may crash again, and there are other factors that may make a new loan impossible. You could end up losing the house if the seller doesn’t want to extend the loan.
If the previous owner has a mortgage on the property, the seller’s lender could demand immediate payment in full for the balance of the seller’s loan. If the seller can’t pay the balance, the bank may foreclose on the home you just bought.
One way to get around a seller’s loan is if the seller retains the title of the property during the loan contract. The danger for buyers is if you default, you lose the house and all the money you have given to the seller already. This moves a lot of risk to you as a buyer and should be avoided if possible.
Are There Risks to Owner Financing Through a Nice Family Member?
While it can be tempting to jump into owner financing with a family member, going through a title company to ensure the property is legally transferrable is a very important step. It is the difference between buying and investing. If the family member selling you the property doesn’t cleanly own it, you can not sell it in the future.
Another downside to owner financing with family is the potential for relationship issues. What happens when there is a late payment? What happens if there are multiple late payments? Grandma and Grandpa aren’t likely to repo your home, but Thanksgiving dinner doesn’t taste as good when you are sitting there thinking about those late loan payments to Grandma as she serves you her famous pie.
The sad truth is, sometimes the problem doesn’t come from the lender (Grandma and Grandpa in our example), but other family members. Whether it is from jealousy or just being mean, sometimes it is other members of the family that want to gossip or complain.
Hopefully this isn’t a problem with your happy family, but as I write this, I think about a friend who started with an owner-financed loan because her parents didn’t want to charge her interest. A few years later she rushed to get a bank loan because her brothers and sisters were raising too much of a ruckus, and she couldn’t stand listening to them anymore.
Should You Get an Owner Financed Loan?
Well, it depends on your situation. You now know the pros and cons. We do have people with an owner financed loan on their land that come to us to buy their home. It does work great for some people.
If you know the downsides and feel like they are unlikely to happen in your case, great! If you feel like there are little red flags raised up while you read this article, take your time and evaluate if it is really the best route. Of course, we are always available to answer any questions you have, so feel free to give us a call.