Friday, December 24, 2010
Owner financing in real estate transactions
Also known as seller financing, owner financing is growing in popularity in today's economy. With the credit markets slowing down and people finding it harder and harder to borrow, owner financing is looking better and better as an alternative to traditional financing. Owner financing is when the seller of the property basically agrees to take payments rather than a lump sum if you aren't buying the home for cash. A seller can lend buyer money for the entire purchase or seller can offer owner financing as a second mortgage if buyer isn't approved for the sale price and both the buyer and seller are otherwise in agreement on the purchase price.
The best case scenario for a seller to offer owner financing is if he/she owns the home free and clear. In other words,owner doesn't need the proceeds from the sale in order to pay off his or her mortgage. Furthermore, the seller does not need the proceeds from the sale of the home for his/her new home
The terms of the purchase and loan need to be right for both parties. The interest rate, duration and repayment structure need to be acceptable for both parties. This usually requires a good deal of negotiation.
Some of the benefits for a buyer and seller to consider if you are entertaining the idea of owner financing:
1. You don't have to get traditional financing if owner finances entire purchase. If seller is willing to finance a portion of the loan, this might help you lower your down payment or help you qualify for traditional financing, but won't completely eliminate traditional financing.
2. Interest rate of loan is independent of market rate. It can be a negotiating tool for buyer and seller to make the deal happen. A seller may offer owner financing and may ask for a higher rate because he/she is taking on a financial risk (that a lender typically would). On the other hand,a seller might offer a lower interest rate if he or she is a motivated seller and buyer is reluctant to go forward with purchase because buyer either thinks mortgage rate is too high and/or buyer cannot afford monthly payments with the market interest rate.
3. As a seller,if you are financially comfortable with owner financing,you could be opening your home to a wider pool of home buyers. One of the biggest benefits for the buyer (if goes with owner financing) is not having to pay the costs associated with conventional loans. Points, origination fees, underwriting charges, appraisal, credit reports, title insurance and other fees charged by conventional lenders can amount to thousands of dollars at closing. The buyer is free from these with an owner-carry installment sale. If a buyer is otherwise approved for a loan,but the closing costs are too much for him/her, owner financing eliminates this objection.
4. If buyer cannot get approved for a loan due to credit score, loan,owner financing is a way to make the deal happen. As a seller, you might be able to be more firm in your terms. There are buyers who are willing to pay a premium for non-qualifying financing Owner financing may also give the buyer a chance to improve his credit rating by owning a home and making payments timely.
5. If purchase is done entirely with owner financing,then settlement date is not held up buy lender financing.
6. If as a home seller,you are many other homes on the market and/or there are homes that buyers might otherwise find more appealing,owner financing might improve the home's appeal since buyers won't have to go through the traditional loan process.
7. As FHA loans have become more popular,with nearly 1/3 of buyers in America using them (August 2010 article in Marketplace),if seller does owner financing,then buyer's loan isn't subject to FHA doing their own inspection of the home for funding purposes of the loan. Some transactions fall apart because FHA lenders won't fund loans based on their home inspections, unless seller or buyer agrees to make repairs. And after the repairs are made,the inspector comes back to approve the quality of the repair. Owner financing eliminates this issue (issues may come up with buyer's home inspector and the FHA inspection is another hurdle).
8. Some transactions fall apart because of the home not appraising. As a seller,if you offer owner financing,one term can be to eliminate the appraisal contingency since you don't need it in order to fund the buyer's loan. Buyer can ask for appraisal contingency,but since seller is loan holder,he/she is able to fund loan so there is no appraisal contingency. Buyer can either agree or disagree to this contingency. If buyer cannot otherwise get a traditional loan,needs owner financing and loves the home,then he or she should give a lot of pause before telling owner that sale is subject to an appraisal. Seller may acquiesce or that could be a deal breaker.
Through traditional mortgages,the lender sends out an appraisor and if in appraisor's professional opinion the home isn't worth the sale price,then the loan won't be approved for the full amount of the sale price and either the seller has to reduce the sale price to the loan price,the buyer come up with the balance in cash to cover the difference between the loan amount and sale price or the buyer and seller have to agree to a compromise. Otherwise the deal falls apart.
Some negatives about owner financing
1. Seller responsible (him/herself or needs to hire somebody) to keep records of monthly payments and buyer's loan balance. An amortization schedule helps to accurately calculate the interest, principal, and remaining balance due. There are also annual 1098 mortgage interest statements to prepare. Many sellers decide to leave all this to a professional and make use of an outside servicer.
2. The duration of the loan. Does seller want to be collecting buyer's loan for perhaps 30 years or does he want to be free and clear of his/her former home in every possible manner? Seller could offer a shorter loan term with a balloon payment at the end.
3. Seller has to become a "collection agency" if buyer not paying loans on time. As the lender, sellers also have to worry if the buyer maintains the property, lets the property insurance lapse, fails to keeps the real estate taxes current, or violates any other terms of the financing arrangement. If seller no longer wants to be the lender and/or needs the money from the entire loan,then he/she has to sell the loan to an investor.
4. If buyer isn't paying loan,seller may need to initiate foreclosure proceedings. One risk for a lender when a home goes to foreclosure is that the property might be worth less than the buyer's outstanding balance.
5. If seller sells home with owner financing and seller also has outstanding loans of his/her own,buyer has to be concerned about seller paying off his/her bills.
There are many things to consider with real estate trasactions involving owner financing and I am sure that I haven't touched on everything.
Before agreeing to owner financing, seller and buyer should consult separate legal counsel in their state. .
If I can be of service in helping you and yours in selling or buying a home,please let me know. I always have time for and greatly appreciate your referrals.
Licensed in MD & DC