With over 90% of mortgage loans owned or guaranteed by the U.S. government, lending requirements have tightened to the point that many otherwise qualified borrowers are unable to buy a home, especially with higher credit score and down payment requirements as well as private mortgage insurance. FHA loans, for example, require mortgage insurance on every loan.
Home sales due to tight lending have been held back as much as 15%, estimates the National Association of REALTORS®. That's left many homeowners and homebuyers frustrated.
Owner financing could be the answer for many. If the parties protect themselves by adhering to state regulations and use reputable sources to help navigate the transaction safely, including their real estate professionals and attorneys, it could be the ideal alternative to bank financing.
What is Owner Financing?
Owner financing simply means that the home's owner carries most or all of the buyer's note. In a volatile real estate market, owner financing can get homes sold that otherwise wouldn't sell, which benefits both sellers and buyers. All it takes is a legal binding agreement that spells out the terms of the loan.
Benefits to sellers
When the seller carries the note, he or she takes the place of the bank, assuming the risks such as defaults and damage to the property, and the rewards such as receiving market value plus monthly interest payments on the note.
A seller can sell a home without having to meet the repair and integrity standards set by FHA and conventional loan lenders.
A popular scenario is that the seller may require that the buyer pay rent-to-own until they accumulate enough for a conventional down-payment. A portion of the money is kept by the seller, and a portion goes into a trust so when the balloon portion of the note is due, the buyer can refinance with a conventional bank loan that pays the seller off.
Benefits to homebuyers
Buyers who have trouble meeting conventional loan standards for any reason are most likely to benefit from buying a home with owner financing. Because the seller collects a monthly interest payment and retains ownership of the home until the terms of financing are met, buyers can typically buy a seller-financed home with little or no money down. But, they can expect to pay higher interest rates for the privilege. The buyer can immediately start enjoying the benefits of homeownership, including rising equity and tax benefits.
Owner financing isn't just for buyers with low credit scores. It can also benefit buyers who want to buy a home but perhaps can't meet the 20% down-payment requirements of a conventional loan.
The Risks in Owner Financing
As in any transaction, there are risks. For the seller, it would be that the buyer stops making payments and loots or destroys the property. But in the case of a default, you take back the property with whatever the buyer has paid forfeited to you.
For the buyer, the risk is that the seller doesn't have clear title to the property, or that the owner-financed loan is tied to the seller's adjustable rate loan, which can be more expensive, some years, than the buyer can afford.
Your real estate agent may be negative about your selling the home this way, because agents are used to the formalities of banks. However, any problems that arise can be managed with proper protections for both sides. Consult a real estate attorney and your real estate professional for more information.