If you are a buyer looking for a property, getting one with an owner loan may save you significant time, effort, and money. Similarly, if you are a property seller, owner financing has the potential to help you speed up the sale process while ensuring that you are properly compensated.

Property finance

Since it is most likely the largest purchase one may ever make, it is often necessary for buyers to get a loan on their property in order to finance the investment. While there are many options in terms of home financing, an owner loan is one that allows sellers and buyers to avoid the complications of involving a third party.

What is owner financing?

A form of home financing, an owner loan refers to the process whereby the party selling a property finances the purchase for the buyer without them having to go through the traditional mortgage process. There are many different aspects involved in owner financing – including lists of pros and cons for both sellers and buyers – that ought to be fully understood and explored before this form of property loan is decided upon.

How does owner financing work?

Unlike a traditional mortgage loan for a property, the seller involved in the transaction replaces the bank or mortgage lender. However, there is no initial exchange of finances between the buyer and seller. Rather, the seller extends credit to the buyer that is sufficient to fully cover the price of the home without a down payment. Both parties agree on the terms of repayment and sign what is referred to as a promissory note.

A promissory note is a means by which individuals or parties obtain loans from sources other than banks. Within the realm of owner financing, a promissory note would usually include:

  • Interest rate

  • Principal amount of repayment

  • Schedule of repayment

  • Consequences of default

  • Signatures of both parties

While stepping away from formal institutions and methods for financing may open a world of possibilities for both buyers and sellers, this form of property loan has both pros and cons for either party.

Pros and cons of an owner loan for buyers

Owner financing has the potential to provide buyers with opportunities they may not otherwise have had, as well as potentially making the process more efficient.

Pros:

  • Alternative way to fund a property investment for buyers who are struggling to find a property which they can mortgage.

  • Fewer administrative hoops to jump through with regards to banks and approvals, thus allowing the process to be quicker and more efficient.

  • Closing costs are generally cheaper as banks will not require fees.

  • Down payments are flexible as there are no minimums required by governments nor banks.

However, despite the above advantages for buyers, there are also multiple cons they will need to face when considering an owner mortgage in the place of other traditional options.

Cons:

  • Since buyers may turn to an owner loan due to being denied by banks, owners may be inclined to offer unreasonably high interest rates as buyers’ borrowing options are limited. Often, interest rates within owner financing schemes are higher than they would be with banks.

  • Despite wanting to sell, many property owners may have existing mortgages that are not fully paid off and include a due-on-sale clause. This means that once the house is sold to another party, the outstanding amount is due in full immediately - failure to do so may lead to foreclosure. There are ways around this, but buyers should always evaluate this as a potential risk.

  • Repayments often end up as large balloon payments after several years, frequently leading to an inevitable loss of large sums of money if repayments cannot be made.

  • Sellers may very well be open to the idea of owner financing, but they need to approve of both the concept and you as the buyer.

Pros and cons of an owner loan for sellers

The process of selling property can be complex and long-winded, but the opportunity of owner financing may offer sellers many significant benefits.

Pros:

  • The process may be far quicker since it is unnecessary to wait for the approval of banks.

  • If the buyer defaults on payments or terms of the purchase, the seller keeps the house and any payments already made.

  • Owner loans may be seen as an investment option and an alternative to other more common methods.

  • Properties may be sold as they are without significant improvements needing to be made.

  • If both parties agree, the promissory note may be sold to a different investor, allowing the initial seller to receive a lump-sum payment.

However, while sellers stand to benefit from owner financing, they also face significant risks.

Cons:

  • Following the 2008 financial crisis (and the subsequent introduction of the Dodd-Frank Act), balloon payments are no longer always an option in these situations and sellers may need to involve mortgage loan originators, depending on the situation.

  • If something happens – perhaps the buyer defaults on payments – and the property is returned to the seller, sellers must accept it in the condition in which it stands.

  • While sellers are reasonably protected in the event of a buyer defaulting on payments, the results may still be inconvenient and even result in foreclosure.

Final thoughts on owner financing

Property owner loans offer both buyers and sellers opportunities that they may not normally have under normal circumstances, making the sale and purchase of properties faster, more efficient and more cost-effective. However, since the process is slightly less formal, it brings with it significant risks and possible additional expenses for both parties. Each situation is unique, so buyers and sellers should ensure that they have evaluated the situation extensively before agreeing to any form of owner financing.

Looking to get a loan for your property? Fill out a free application form today and compare different loan options with Lendela.