What Is Owner Financing? A Beginner’s Guide

Owner financing is when the seller serves as the lender. The buyer makes payments directly to the seller instead of getting a mortgage through a conventional lender. This type of financing may be a good fit when a buyer isn’t able to qualify for a traditional mortgage.

There are both pros and cons of owner financing for both parties. Keep reading to find out how owner financing works, common types, the pros and cons for both parties and more. Whether you’re buying or selling a home, you’ll learn everything you need to know about owner financing.

How Does Owner Financing Work?

Owner financing — sometimes known as seller financing — is a real estate agreement that occurs when homeowners sell their property and let the buyers purchase their home without relying on traditional lenders for a loan. Instead, the agreement is directly between the buyer and the seller, with no third-party lender involved.

When using owner financing, the buyer and seller must agree to a down payment, interest rate, loan term and other characteristics of the loan. This type of financing may have a higher interest rate than a traditional loan and often requires a balloon payment. Owner financing typically requires installment payments over a shorter period than is available for a traditional loan.

Unlike with a traditional loan, there’s typically no escrow, meaning the new owner will pay their homeowners insurance and property taxes directly to their insurance company and local government, respectively.

Because there’s less regulation and no third-party lender involved, buyers and sellers may be able to negotiate more terms with owner financing than is possible with a conventional mortgage. This back-and-forth typically happens while negotiating the offer. Keep in mind, because there’s less regulation, these loans can be very high risk.

Common Types Of Homeowner Financing

There are several types of owner financing to choose from. The best option will always depend on the unique circumstances of the sale, as well as the financial situations of both the buyer and the seller.

Assumable Mortgage

An assumable mortgage allows a home buyer to take over — or assume — the seller’s mortgage. The buyer will have the same interest rate, repayment period, loan amount and monthly payment. However, because the loan amount remains the same, the borrower would have to cover the assumption gap, meaning the difference between the house’s sale price and the value of the mortgage.

Assumable mortgages are rare and are generally only allowed for certain government-backed loans. As a result, this option isn’t appropriate for most situations.

Wraparound Mortgage

When a wraparound mortgage is used, the seller maintains their existing mortgage, and the buyer obtains a second form of financing to wrap around the current loan amount. The buyer typically makes monthly payments to the seller, usually at a higher interest rate. The seller then makes the mortgage payment to the lender for their existing mortgage.

Land Contract

A land contract is an agreement between a buyer and seller that allows the buyer to pay for the property in monthly installments, similar to a mortgage. However, the seller often maintains the legal title to the property until the contract is fully paid. The buyer gets equitable title, meaning they can build equity in the property. Only once the contract is fully paid does the buyer get full title to the property.

Lease Purchase Agreement

A lease purchase agreement, also known as a rent-to-own agreement, allows a home buyer to rent or lease the property from the seller for a certain period. At the end of the contract, the buyer has the right to officially purchase the property from the seller. In many cases, a portion of the monthly rent payments goes toward a down payment on the sale.

Pros And Cons Of Owner Financing For Sellers

Owner financing can make it easier for a homeowner to sell their home, but it also comes with some downsides.

Pros

• Attract more buyers: Owner financing can help a seller to attract more interested buyers, especially during certain market environments where people are having a more difficult time getting traditional mortgages.
• Ask for a higher sale price: You may be able to get a higher sale price on your home when using owner financing than you would if the buyer was using traditional financing.
• Charge interest: When you use owner financing, the buyer must pay interest just as they would on a traditional mortgage. But instead of a bank collecting the interest, you are.
• Faster closing: Owner financing can lead to a faster closing since you don’t have to wait for the buyer to go through the underwriting process. This may be especially beneficial if you’re moving into a new home and want to speed up the process.

Cons

• Buyer evaluation: With a traditional mortgage, the lender evaluates whether the buyer is able to repay the loan. But with owner financing, you must make that assessment.
• Risk of buyer default: When you sell a home using owner financing, you take on all the risk that a mortgage lender normally does. If the buyer defaults on the loan, you may have a difficult time getting your money back.
• Tax impact: The interest you receive through the owner financing could result in additional taxable income, which could increase your income taxes.
• No cash upfront: When you sell your home with owner financing, you won’t receive the cash for your property upfront as you would in a traditional sale.

Pros And Cons Of Owner Financing For Buyers

Just as there are pros and cons to owner financing for sellers, there are also some pros and cons for buyers to consider.

Pros

• Cheaper and faster closing: Using owner financing helps avoid the long closing time that comes with a traditional mortgage, as well as many of the typical fees.
• Flexible requirements: Owner financing may offer more flexible requirements — or no requirements at all — in terms of down payment and credit score.
• Open negotiations: When you’re getting a traditional mortgage, there’s often little room for negotiation. But with owner financing, you can negotiate more aspects of the deal.
• Access to financing: Owner financing can help you get a loan and buy a home when your credit and finances may otherwise not allow you to.

Cons

• Limited property choices: Most sellers don’t offer owner financing, so your property options may be severely limited if it’s your only option.
• Higher interest rates: Owner financing typically comes with higher interest rates than traditional loans (though these are negotiable).
• Balloon payments: Owner financing typically requires a balloon payment at the end of the term, which is typically quite large and will require appropriate planning and saving.
• May not build credit: Your credit score won’t get a boost from owner financing as it would from a traditional loan since your payments won’t be reported to the credit bureaus.

When Should You Consider Owner Financing?

Owner financing isn’t right for all situations, but there are times when both a buyer and a seller can benefit from it. Here are a few examples.

For Sellers 

Below are some situations when a seller may want to consider owner financing.

Slow Market

If you’re trying to sell your home in a buyer’s market, offering owner financing can make your home more appealing and can attract buyers who may otherwise not have been interested.

Property Restrictions

Unique property features and restrictions can make it more difficult to attract buyers or for those buyers to get traditional financing.

No Immediate Funding Need

Owner financing may be worth considering if you don’t need the cash from the sale immediately. In fact, you can get more money in the long run by charging a higher sale price and getting interest on the loan.

For Buyers

If you’re considering buying a home, these are some situations where you may consider owner financing.

Trouble Qualifying For A Mortgage

If your credit history, lack of a down payment, or anything makes it difficult for you to qualify for a traditional loan, owner financing may be your only option for homeownership.

Self-Employed Or Irregular Income

It’s often difficult to qualify for a mortgage when you’re self-employed or have an irregular income. Lenders prefer to see consistent income from an employer. However, owner financing may be more flexible.

Personal Relationship

Owner financing may be popular when the buyer and seller have a personal relationship. For example, parents may offer owner financing when selling their home to help their child buy it.

Owner Financing: Next Steps

If you’re considering owner financing, it’s important to consult the appropriate real estate professionals to guide you through the process, regardless of whether you’re the buyer or seller.

• Work with a real estate agent: A real estate agent can help you identify homes where seller financing may be an option. They can also help you negotiate an offer, collect paperwork and facilitate the closing process.
• Consult a real estate attorney: A real estate attorney can help you review all contract language and make sure you understand what you’re agreeing to. Your real estate agent should be able to provide them with attorney recommendations.

Alternative Financing Options

There are many financing options available. Even if a property is listed as having owner financing available, you don’t have to go that route. Additionally, if you have poor credit or otherwise can’t qualify for a conventional loan, there are still other options available to you.

• Federal Housing Administration (FHA) loans: FHA loans are popular for first-time home buyers and buyers with below-average credit. They have flexible credit score and income requirements to make it easier for low and moderate-income borrowers to buy homes.
• U.S. Department of Agriculture (USDA) loans: USDA loans can help low and moderate-income borrowers in rural areas buy homes. They have competitive interest rates and don’t require a down payment, nor do they require mortgage insurance. Not all lenders offer these loans. For example, our sister company, Rocket Mortgage® does not currently offer USDA loans.
• Interest rate buydowns: If you’re concerned about being able to afford your monthly payment, consider an interest rate buydown, which can be used with any type of mortgage.
• Down payment assistance: If the down payment is a major hurdle preventing you from being a home, consider applying for down payment assistance programs in your state to help remove that high upfront cost. It’s important to know that not all lenders accept all programs. It’s best to speak with a loan expert to see which programs are accepted.

FAQs About Owner Financing

Are you considering buying or selling a home with owner financing? Here are a few more things you may need to know.

Who holds the deed in owner financing?

Who holds the deed in owner financing depends on the type of owner financing you use. With an assumable mortgage or a wraparound mortgage, the buyer holds the deed right away. But with a land contract or lease purchase agreement, the seller maintains the deed until the contract states otherwise.

Who pays property taxes in owner financing?

In most cases, the buyer is responsible for all property taxes when using owner financing. Because property taxes aren’t included in the mortgage payment as they would be with a traditional mortgage, the buyer must pay the taxes directly to the local government.

Does owner financing hurt your credit?

Owner financing shouldn’t hurt your credit unless you default on your loan. However, it also may not boost your credit unless there’s a loan from a third-party lender involved.

Why would someone offer owner financing?

Someone may offer owner financing to make their house more appealing to buyers, especially when there’s a buyer’s market. Someone may also offer owner financing to a loved one to help them buy their home.

The Bottom Line: Read The Fine Print When Considering Owner Financing

Owner financing can make homeowners more accessible to buyers. However, it has major downsides for both the buyer and seller. There’s considerable added risk for the seller and often added costs for the buyer. It’s important to consult a real estate attorney to ensure agreements are drafted in a way that protects you.

If you’re considering selling your home, sell with Rocket Homes℠ today.