Owner Financing for Mortgages Explained

June 2024 · 12 minute read
2024-07-20T20:11:41Z JUMP TO Section Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.
  • Definition
  • How it works
  • Benefits
  • Potential risks
  • Alternatives
  • Steps to take before agreeing to owner financing
  • FAQs

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    Owner financing — sometimes referred to as seller financing — is one alternative that can help homebuyers get into a home of their own if they don't qualify for financing with a traditional mortgage lender.

    But owner financing can be risky for both the buyer and the seller. Here's what you should know about these types of mortgages, regardless of which side of the transaction you're on.

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    Definition of owner financing

    Owner financing is a home financing deal in which the seller of the property acts as the mortgage lender, providing financing to the homebuyer.

    How owner financing works

    The buyer and seller must come to an agreement on the terms of the loan, including the mortgage rate and length of repayment. Then, the buyer will make a down payment toward the home purchase and pay off the rest through monthly installments according to the owner financing agreement.

    In general, sellers can only offer financing if they own their home outright, with no existing mortgages or loans on the property. Otherwise, they'd need approval from their lender first. 

    The agreement process

    Owner financing agreements can take different shapes depending on the circumstances of the sale. For example, if a buyer is able to qualify for a traditional mortgage but the amount they can borrow isn't enough to cover the purchase price, a seller might offer financing to cover the remainder. Or, if the buyer doesn't qualify for a mortgage at all, the seller may finance the full amount being borrowed.

    If the seller is still paying off their current mortgage, the financing might be structured as a "wraparound" loan, where the seller maintains the buyer's mortgage on top of their own.

    The buyer and seller will need to negotiate the terms and come to an agreement that works for both parties.

    Terms and conditions

    "Typically, the seller and buyer will agree to terms such as the interest rate, how many payments per year, and how many years the loan is amortized over," says Pratik Pathapati, owner of real estate investment company Rework Cash Offers in Sacramento, California.

    Owner financing deals often have higher interest rates than what you'll find in the traditional mortgage market. They also typically have shorter terms and end with balloon payments that are owed after a certain number of years.

    "Many times the seller will want what's known as a balloon payment within 10 years, which is when the buyer will need to pay off the entire loan, usually through refinancing the loan with a bank," Pathapati says.

    Once the seller and the buyer agree on the terms, they'll make the deal official using a legal instrument such as a promissory note, which makes it legally binding.

    Owner financing example

    Let's say a homebuyer is using owner financing to purchase a home for $200,000. They make a 20% down payment and finance the remaining $160,000 at a rate of 8%. 

    The buyer and seller agree to a mortgage with a 30-year amortization schedule — meaning payments are set up to pay off the loan, including principal and interest, over the course of 30 years — that ends in a balloon payment after 10 years of payments.

    This means that the buyer will pay $1,064 each month to the seller. If this were a traditional mortgage following the 30-year amortization schedule, this monthly payment amount would allow the loan to be fully paid off after 30 years. 

    But under the terms of this mortgage, the buyer only makes payments for 10 years before the remainder of the loan is due. So after 10 years of making monthly payments, the buyer must pay the seller the remaining principal balance, which would be around $137,000.

    At this point, the buyer may have enough equity in the home to qualify for traditional mortgage financing to pay off the loan provided by the seller.

    Benefits of owner financing

    "Owner financing is uncommon in today's real estate market but can be beneficial in a number of ways," Pathapati says. "The terms of the loan are not bound to specific standards so both seller and buyer can get creative in how the loan gets paid back."

    Because an owner-financed loan agreement isn't held to the same rules and regulations as a traditional mortgage, the sale can be completed faster and with fewer costs. For example, the buyer will only need to pay for an appraisal if they want to get one.

    For buyers

    Here are some common reasons a buyer might benefit from an owner financing agreement:

    For sellers

    Some of the main benefits of owner financing from a seller's perspective are:

    Potential risks and how to mitigate them

    The risks that come with these transactions are why they tend to be more common between people who already know each other, such as family or friends, rather than two strangers.

    "The main risk with owner financing is that the buyer needs to fully understand the structure and terms of the loan," Pathapati says. "Any misunderstanding can later cause problems for the buyer and seller."

    Risks for buyers

    Some downsides and potential risks for buyers getting owner financing include:

    As a buyer, you want to avoid entering into a loan agreement that you ultimately can't afford. If you aren't sure you'll be able to cover a balloon payment when the loan comes due, you risk losing your home. 

    Risks for sellers

    These agreements can also be risky for sellers. Some drawbacks include:

    Sellers need to do their due diligence to ensure that their buyer is creditworthy, or they risk losing a significant amount of money.

    Mortgage lenders are set up to deal with defaults and have insurance to protect them from loss related to foreclosure. For an individual seller offering financing, that process would likely end up being time-consuming and expensive.

    Protect yourself with an attorney

    An owner financing agreement is a legal contract, just like the contract between a buyer and a traditional mortgage lender.

    Both parties should be represented by a real estate attorney who's experienced with these types of contracts. This will help mitigate the legal risk that can come with owner financing transactions.

    Alternatives to owner financing

    Traditional mortgages

    Ideally, the homebuyer would get a traditional conventional or government-backed mortgage to pay for the home, since these come with less risk and lower rates. But owner financing is often sought because the buyer doesn't qualify for traditional financing.

    Rent-to-own agreements

    In a rent-to-own agreement, the homeowner rents the property out to the prospective buyer and gives them the option to buy the property after a certain period of time.

    Depending on the terms of the agreement, a portion of the rent may be credited toward the buyer's down payment. The renter may also have to pay an upfront fee to secure the rent-to-own option. 

    Land contracts

    A land contract is a form of owner financing where the buyer doesn't receive the deed to the home until they fully pay off the loan. These agreements can be less risky for the seller, since they wouldn't have to initiate the foreclosure process if the buyer defaults. They would have to evict the buyer though, which can be its own complicated process. And they're ultimately on the hook for things like property taxes. 

    Steps to take before agreeing to owner financing

    Due diligence for buyers

    As a buyer, it's important to make sure you're working with a reputable seller. And even though you won't be required to go through things like an appraisal or title search, it's probably a good idea to pay to have both done, to be sure that the home is worth what you're paying for it and that its title is clear. 

    Preparing for sale as a seller

    Sellers should be sure they understand the terms of the agreement and what options they have available if their buyer stops making payments.

    If the buyer isn't able to qualify for a traditional mortgage due to a poor or insufficient credit history, you may want to look at alternative means of verifying their creditworthiness. This could include asking for proof that they've kept up with rent payments in the past.

    Owner financing FAQs

    Why would someone offer owner financing? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.

    A seller might utilize owner financing because they're looking to earn investment income or because they want to sell their home as-is without having to go through the traditional lending and appraisals processes.  

    What are the typical terms of an owner financing deal? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.

    There's no standard way to structure an owner financing deal, so the terms can vary widely. Buyer and seller will need to negotiate on the interest rate, down payment, and repayment schedule.

    Is owner financing safer than a traditional mortgage? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.

    Owner financing is often riskier than getting a traditional mortgage, which is why it's most often utilized by buyers who can't secure traditional financing.

    Can any property be purchased with owner financing? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.

    A property can be purchased with owner financing only if the seller agrees to it and if the seller has the authority to offer this type of financing. If the seller already has a mortgage on the property, they would likely need the lender's permission before offering owner financing.

    How does owner financing affect a seller's taxes? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.

    An owner financing agreement could be helpful to the seller if they would owe a lot in capital gains from the home sale, since they could potentially spread out this tax liability over a number of years. But capital gains on a home sale are only owed in certain circumstances. It's best to talk with a tax professional to find out what strategy is right for you.

    What happens if a buyer defaults in an owner financing agreement? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.

    It depends on what's in your contract, but typically the seller will be able to foreclose on the property if the buyer defaults.

    Does owner financing hurt your credit? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.

    No, owner financing shouldn't hurt your credit, since these deals typically aren't reported on the buyer's credit report. However, this means your credit also won't benefit from making on-time payments each month.

    Is seller financing a good idea? Chevron icon It indicates an expandable section or menu, or sometimes previous / next navigation options.

    Seller financing can be advantageous for buyers who don't qualify for traditional financing, or for sellers who want to start earning investment income. But there are risks as well, and it can be more expensive than traditional financing.

    spanMolly Grace is a mortgage reporter for Business Insider with over six years of experience writing about mortgages and homeownership. /spanspanExperience/spanspanIn addition to her daily mortgage rate coverage, Molly also writes mortgage lender reviews and educational articles on homebuying and analyzes data and economic trends to give readers actionable and up-to-date information about the housing market./spanspanShe also tracks affordable mortgage and down payment assistance programs offered throughout the country to keep her readers informed of homebuyer programs available to them. /spanspanBefore Business Insider, Molly was a blog writer for Rocket Companies and helped to create Rocket Mortgage’s Shorty Award-winning podcast Home. Made./spanspanMolly is passionate about covering personal finance topics with empathy. Her goal is to make homebuying knowledge more accessible, especially for groups that may think homeownership is out of reach. /spanspanExpertise/spanspanMolly is an expert in the following topics:/spanullispanMortgages and mortgage lenders/span/lilispanHome equity/span/lilispanThe housing market/span/lilispanThe economy and the forces that impact mortgage rates/span/lilispanBudgeting and saving/span/lilispanCredit/span/lilispanInsurance/span/lilispanRetirement savings/span/li/ulspanEducation/spanspanMolly earned a bachelor's degree in journalism from Indiana University. /spanspanShe is based in Michigan and has a dog and two cats. /span Molly Grace Mortgage Reporter Molly Grace is a mortgage reporter for Business Insider with over six years of experience writing about mortgages and homeownership. ExperienceIn addition to her daily mortgage rate coverage, Molly also writes mortgage lender reviews and educational articles on homebuying and analyzes data and economic trends to give readers actionable and up-to-date information about the housing market.She also tracks affordable mortgage and down payment assistance programs offered throughout the country to keep her readers informed of homebuyer programs available to them. Before Business Insider, Molly was a blog writer for Rocket Companies and helped to create Rocket Mortgage’s Shorty Award-winning podcast Home. Made.Molly is passionate about covering personal finance topics with empathy. Her goal is to make homebuying knowledge more accessible, especially for groups that may think homeownership is out of reach. ExpertiseMolly is an expert in the following topics:EducationMolly earned a bachelor's degree in journalism from Indiana University. She is based in Michigan and has a dog and two cats.  Read more Read less Top Offers From Our Partners Chime® Checking Account Set up Direct Deposit and get your paycheck up to 2 days before your coworkers.** No overdraft fees. No monthly fees. A tooltip Chime is a financial technology company, not a bank. Banking services provided by The Bancorp Bank, N.A. or Stride Bank, N.A., Members FDIC. **Early access to direct deposit funds depends on the timing of the submission of the payment file from the payer. We generally make these funds available on the day the payment file is received, which may be up to 2 days earlier than the scheduled payment date. Start Banking

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