When buying a house, a common practice is getting a mortgage to finance the purchase. But what if you don’t qualify for getting a mortgage?
There is a silver lining for those who don’t qualify with a traditional lender.
One of the options would be owner financing. In this case, a homebuyer gets the loan directly from the seller instead of going through the strict lending requirements.
Undoubtedly, buying a house is one of the most significant investments that you will ever make. Thus homebuyers need to rely on some type of financing to make the purchase. When choosing owner financing, both parties need to agree on the terms and conditions of the loan, and the seller has the buyer sign a promissory note that details the loan.
It includes the term, repayment schedule, interest rate, and consequences of default.
Owner financing is usually not reported on the buyer’s credit report. A substantial down payment is generally required (usually 10 to 20 percent) to compensate for the fact that the financing isn’t dependent on the buyer’s income or credit history. However, some sellers perform a credit check before giving the loan.
Owner financing is usually more expensive than traditional financing from a lending institution. Although, it can be a viable option for those who don’t qualify for funding through a conventional lender. But before jumping into getting this type of arrangement, let’s see some of the pros and cons of owner financing.
Pros of owner financing for buyers
1. Alternative for buyers who don’t qualify for financing
It can enable financing for borrowers that may not otherwise qualify. For example, suppose you have an irregular income or a low credit score. In that case, you may have more trouble securing a mortgage loan from a traditional lender, which makes owner financing a viable option.
2. A shorter diligence period
Allows buyers and sellers to shorten the due diligence period for a faster closing. For instance, the buyer doesn’t need a home appraisal to secure financing from their bank.
It means you can close the deal faster, benefiting both the buyer and seller.
3. Lower closing costs
Reduces the cost of closing by eliminating some costs associated with appraisal, bank fees, and inspections. You can make considerable savings by avoiding these costs, which you can use for other purposes such as refurbishment for the new house or as part of the down payment.
4. Flexible down payment
With owner financing, there is no minimum down payment required as there would be with a Federal Housing Administration (FHA) loan. That means the buyer could try to obtain a lower down payment if the seller agrees, but it depends strictly on the seller’s willingness. Not many agree to a lower down payment, but if you are persuasive enough, you might get lucky and save some bucks.
Cons of owner financing for buyers
1. Balloon payment
If the financing arrangement has a balloon payment clause, buyers might have to pay a considerable amount at the end of their loan term. A balloon payment consists of a larger-than-usual one-time payment at the end of the loan term.
If you think about a balloon loan, you need to consider whether and how you can make the balloon payment when it comes due.
2. Higher interest rates
Owner financing usually means a higher down payment and interest rates for buyers, which makes the home’s total cost higher than a traditional mortgage. Usually, sellers, to make up for the fact that the buyers might have a low credit score and avoid any risks that may occur, ask for a larger down payment and higher interest rate. Many deals require a 20% down payment.
3. Due-on-sale clause
A due-on-sale clause allows a lender to request full repayment of a loan if the borrower sells the house used to secure their loan.
This clause is used in home mortgages and prevents homeowners from selling their homes before paying off their debt. If the borrower attempts to sell the property without the lender’s consent, the lender may foreclose upon the property. To avoid this risk, ensure that the seller owns the house free and clear or that the seller’s lender agrees to owner financing.
4. Less availability
Finding a seller willing to agree on this financing might take time and effort. Not all sellers are willing or able to offer owner financing.
Also, as a buyer, it would be better to have a real estate attorney representing your best interests when signing the contract.
Pros of owner financing for sellers
1. Sell faster
You will probably close the sale process faster with owner financing, as the buyer avoids the mortgage procedure.
Most people go through several stages when looking for a new mortgage: pre-approval, house shopping, mortgage application, loan processing, underwriting, and closing. All these take a lot of time and effort, especially for the buyers, but the sellers are also affected.
2. Retain title
If the buyer can’t keep up with the payments or doesn’t follow the terms of the agreement, the seller can keep the down payment or any other sum that was paid, and of course, the house. Usually, all agreements contain a retention of title clause which means that the seller retains legal ownership of the goods until certain obligations are fulfilled by the buyer, usually payment of the purchase price.
3. A good investment
For the seller, it can be another source of income. Since the seller has leverage on the buyer because he’s financing the sale himself, he can get a higher asking price. Also, the seller will likely charge a higher interest rate than a lender to generate interest income.
4. Few property requirements
With owner financing, you can sell your house as it is. There’s no need for costly repairs that traditional lenders might require.
Cons of owner financing for sellers
1. More work
Owner financing might require a lot of time and effort for the seller. Sellers should check the buyer’s credit report, confirm their income, and many more. They should see whether the buyers are trustworthy to diminish the risks of owner financing.
2. Laws can be complicated
Federal and state law can limit owner financing contracts and balloon loans as a matter of consumer financial protection. It involves more risks for the seller.
3. Ownership required
If you’re selling your home in an owner-financing agreement, you must first pay off your mortgage and have the title in hand.
4. Possible repair costs
If you are forced to initiate foreclosure and take back the house for whatever reason, you might have to pay for repairs and maintenance, depending on how well the buyer took care of the property.
While it’s not as common as a traditional loan, owner financing can be a good option for buyers and sellers under the right circumstances. Still, there are risks for both parties involved. Thus before signing any type of contract, you should carefully weigh the pros and cons of this type of arrangement.
If you’re considering owner financing, it’s generally in your best interest to work with a real estate attorney qualified to represent you during negotiations and review the contract to protect your rights.