If you’re a first time home buyer, you will come across some terminology that is unfamiliar during your home buying journey. One such term that you may encounter is “owner financing.” Traditionally, buyers obtain financing through a lender in the form of a mortgage. Owner financing, however, is a little bit different and doesn’t follow this standard route. In addition, there are also different risks and costs involved. Below, we’ve explained owner financing in detail and some important factors that prospective buyers should consider.
How Does Owner Financing Work?
Owner financing is a non-traditional type of home financing. It’s a process in which a homebuyer obtains a loan from the home seller rather than a mortgage lender. Most commonly, the owner records a mortgage against the property, which is sold through a deed transfer to the buyer.
There are different types of owner financing but, generally speaking, the process works something like this:
- The buyer moves into the home after making a down payment.
- After moving in, the buyer makes regular payments to the seller at a fixed interest rate for about 5-10 years.
- After this specified time, the mortgage comes due, and the buyer makes a balloon payment. (Usually, a buyer will secure a refinance loan to make the balloon payment.)
What Are the Risks of Owner Financing?
Generally, owner financing is pursued by borrowers who cannot qualify for a traditional mortgage. This may be due to bad credit, lack of employment history, or needing more funds for a down payment. Owner financing may also be pursued if a seller wants to sell their property faster than conventional financing would allow. That being said, there are some risks involved with this type of home financing transaction.
Some of the risks of owner financing for buyers include:
The interest rate offered by the seller may be higher than those offered by a lender.
Due on Sale Clause
Most mortgages have a due on sale clause. This clause requires borrowers to repay their lender once they sell their home. If the lender isn’t paid, they can foreclose on the home. In the case of an owner financing situation, this may cause the would-be homeowner to lose the home and no longer have a place to live.
Some buyers have trouble procuring funds to pay for the balloon payment. If you cannot secure funds to make this payment, you may not only lose the home but also lose all the money you’ve paid so far over the years.
Lack of Protection
The buyer may have limited protection under consumer protection laws, since owner financing terms and conditions are often not regulated.
If you have questions about owner financing or would like to explore other home financing options, please do not hesitate to give us a call. We would be more than happy to assist you!