WHAT IS OWNER FINANCING & HOW DOES OWNER FINANCING WORK?

What is owner financing?  Also known as seller financing, owner financing is essentially where the seller acts as the lender and loans money to the buyer in a real estate transaction.  

How Does Owner Financing Work?

Now that you’ve got an answer to “what is owner financing?”, let’s talk about how owner financing works.  With owner financing, the buyer and seller both sign either a promissory note or a land contract.  In either case, the following would likely be included:

  • lender name(s)
  • borrower name(s)
  • date of the loan
  • loan amount
  • date loan will be repaid in full
  • payment frequency
  • interest rate
  • consequences of default
  • place for both parties to sign

Land contracts are also known as Installment contracts, land installment contracts, or contract for deed.

Difference Between Equitable Title & Legal Title

Before we go any further, you need to know the difference between “equitable title” & “legal title.”  

If you have “equitable title” in a property, you have a legal right to obtain ownership of the property, but you don’t own the property yet.  “Legal title” means you actually own the property.  

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While there are certain rights associated with each, the main point is that with legal title YOU OWN the property, and with equitable title YOU DO NOT OWN the property.

Differences Between Promissory Notes & land contracts

To answer the “what is owner financing?” question, you need to understand the difference between promissory notes and land contracts.

The most important difference is how the title is handled.  In a land contract, the buyer receives equitable title and the seller maintains legal title.  With a promissory note, the buyer receives legal title.  

In other words, in a land contract, you do NOT own the property until you satisfy the terms of the contract (pay the seller in full).  With a promissory note, you take ownership at closing.

similarities Between Promissory Notes & land contracts

Promissory notes and land contracts are similar in the sense that they both layout the loan terms agreed upon between a buyer and seller in a real estate sale.  Additionally, both scenarios will likely be short-term usually requiring a balloon payment within 5 years.  

This means that although monthly payments may be amortized over 20 or 30 years, if a balloon payment is due in five years, then, at the five year mark, the seller wants to be paid off in one lump sum.  

In this example, the buyer would have 5 years to work out permanent financing with a bank or other lending institution.

Reasons Promissory Notes Are Better For Buyers

Promissory notes are typically better for the buyer because the buyer receives legal title.  One of the biggest advantages to receiving legal title is the safeguard you have against the seller getting foreclosed on.  Let me explain by creating an example.

Let’s say you sign a land contract with a seller to purchase a house for $100,000, and the seller has an existing mortgage on the property.  

You receive equitable title and begin making monthly payments to the seller.  All seems to be going well, but what you don’t realize is that the seller has not been making his mortgage payments, and after a few months the bank forecloses on the property.

What do you think happens to your down payment along with all the monthly payments you’ve been making?  Gone.  The bank takes the house, and the deal is off.

Why Land Contracts Are Better For Sellers

With a land contract, the seller maintains ownership by holding on to the legal title.  One of the biggest advantages of maintaining legal title for the seller is when the buyer defaults on their payments.  

If you, as the seller, have legal title, getting the buyer out of the property via what’s called a forfeiture may work very similar to filing an eviction against a tenant.  However, if you as the seller, passed legal title to the buyer, you would need to actually foreclose on the property to get the buyer out.  A foreclosure can be a lengthier and more costly process than a forfeiture.

Here’s a great video that explains more about land contracts:

Why Would A Seller Owner Finance?

Not always, but usually sellers who are willing to owner finance are motivated to sell for one reason or another.  Maybe they need to move for job relocation or perhaps the property has sat on the market for a lengthy period of time, and they are eager to get rid of it.  Whatever the reason, you’re usually dealing with a motivated seller.

However, there may be cases where the seller has other reasons for offering owner financing such as:

  • to get full asking or even above asking price
  • receive higher monthly payments compared to renting
  • minimize risk of theft and vandalism by getting property sold faster

 

Why Would A Buyer Owner Finance?

A buyer would typically owner finance because either they can’t qualify or come up with the required down payment for a bank loan.  Although seller financing may come with a higher interest rate and purchase price compared to conventional financing, seller financing can be a viable way for people to obtain homeownership sooner rather than later.

Conclusion

In this post, I’ve hopefully answered “What is owner financing?” & “How does owner financing owrk?”  While there is much more to be said about owner financing, the main takeaways from this post is the following:

  • Owner financing allows the the buyer to finance directly with the seller and bypass the banks
  • Owner financing agreements will likely be either a promissory note or a land contract
  • With a promissory note, the buyer receives ownership of the property by receiving legal title.  With a land contract, the seller maintains ownership and passes equitable title to buyer.  
  • Owner financing presents various advantages and disadvantages for both buyers and sellers.

 

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