Owner Financing: What Is It and Should You Apply?
By comparison, terms and eligibility requirements for owner financing are much less strict. This makes it a viable alternative for borrowers who may not qualify for traditional real estate loans.
However, owner financing isn’t just an alternative for borrowers with low credit scores. In many cases, buyers that qualify for traditional financing prefer owner financing to other funding programs.
Still, owner financing isn’t the best business financing option for everyone. To help you decide if it’s right for you, we’ll review what owner financing is and the most notable pros and cons.
Owner Financing Definition: What is Owner Financing?
Owner financing, also called seller financing, occurs when a property seller and buyer structure the purchase as an installment sale. In this transaction, the buyer makes a down payment on the property and pays the balance in installments.
How Does Owner Financing Work?
The easiest way to understand owner financing is to compare it to a traditional real estate transaction. In traditional transactions there are three parties; the bank, the buyer, and the seller. The buyer uses funds from a bank to pay the seller and the seller transfers the property deed to the buyer.
In seller-financed transactions, the bank isn’t involved. Instead, the buyer makes a down payment and gives the seller a promise to pay the balance which is secured by a promissory note and mortgage.
For example, suppose you want to buy a property that isn’t eligible for a commercial real estate loan. You could offer to buy the property for $100,000 with a $30,000 down payment. If the seller agrees, they’ll finance the remaining $70,000 at an interest rate of 10 percent for five years. At the end of five years, you’ll owe a balloon payment for the balance of the loan.
The Advantages of Owner Financing for Buyers
1. Less stringent applications processes and qualification criteria
Private real estate owners don’t face nearly as much regulatory scrutiny as traditional lenders do. Also, they’re not beholden to stakeholders that have strict financial performance demands and risk tolerances.
As a result, owner financing tends to have significantly less stringent qualification criteria than traditional real estate financing. That also means there will be less paperwork for you to complete as a borrower. Therefore, if your lack of credit history is stopping you from securing traditional financing, owner financing can be an alternative.
Owners will still run a credit check to review your credit history. However, they won’t necessarily automatically disqualify you for a low score.
2. There’s room for negotiation
Even if they wanted to, traditional lenders aren’t in a position to negotiate. They have strict parameters in terms of rates, down payment requirements, loan length, and more. With owner financing, though, all the terms of your loan are—at least theoretically—negotiable.
If you’re an effective negotiator, you may secure more favorable terms with owner financing than you could otherwise. At the very least, you can negotiate with the seller to structure your financing arrangement in more creative ways.
3. Closing costs are lower
As we touched on earlier, there’s no bank involved in an owner-financed transaction. That means you can avoid the many closing costs associated with traditional lenders.
With owner financing you don’t pay origination fees, discount points, escrow deposits, mortgage insurance, or other fees. Closing costs generally amount to three to six percent of the property’s purchase price so the savings are significant. For example, on a property that costs $500,000, you could easily save $5000 or more in closing costs.
The Drawbacks of Owner Financing for Buyers
1. Often requires a balloon payment
While there’s no rule that owner financing must be structured with a balloon payment, that’s usually how it works. This is because, most of the time, buyers use owner financing with the expectation that they’ll be able to secure traditional financing later. Once they’ve secured traditional financing, the buyer can pay off the balloon payment with the loan proceeds.
Balloon payments are large payments of the remaining balance of a loan. Therefore, if you don’t have financing secured to pay off a balloon payment, it will have a major — potentially catastrophic — cash flow impact.
2. Not always available
As mentioned, there’s no bank involved in owner financing, but there’s still a lender: the seller.
As the lender, the seller is subject to default risk—the risk that the buyer doesn’t make their monthly payments. Many sellers don’t want to take on this risk, especially because they may not be as skilled as a bank at evaluating borrowers’ risk profile.
All this to say, if you’re looking for owner financing to purchase real estate, you may have trouble finding a willing party. This is why seller financing is far more prevalent in buyer’s markets when buyers have more leverage. Also, even if a seller is willing, certain mortgages have due-on-sale clauses that prevent the seller from offering owner financing.
3. May be more expensive than traditional financing
Owner financing cuts out closing costs and is open to negotiation, but that doesn’t mean it’s more affordable. Generally, owner financing is offered to buyers who can’t qualify for traditional financing. Knowing that a borrower can’t qualify, owners are likely to charge higher interest rates than that of a traditional mortgage.
Conclusion: Determine If You Should You Apply for Owner Financing
Only property owners can offer owner financing, and not many do, so there aren’t strict qualification standards. This means that owner financed deals can be great in some cases, and not as beneficial in others. It all depends on the owner, buyer, and the property. Therefore, it’s impossible to generalize as to whether you should apply for owner financing.
However, if it’s available, and you’re unable to qualify for traditional financing, it’s certainly worth considering. The decision to apply or not depends upon your financial situation and the terms offered.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.