How does owner financing work?

Buying a house is usually one of the biggest financial decisions you would take. Everyone would like to own a dream house, but it would obviously cost money and usually, it would be big money.When you decide to buy a house, in all probability, you would look for financing to help you raise funds for your purchase. In most cases, people approach banks for a mortgage loan.

Owner financing is an option you can consider to raise finance to buy a house. 

What is owner financing?

In owner financing, instead of taking money from a bank or a lender, you get the financing from the seller or the owner of the house. This is why it is also called as seller financing. When you get financing from a bank, you borrow money and buy the house and repay the loan to the bank every month in installments, till you clear the loan. If you go for owner financing, you approach the owner of the house and obtain credit from him. The owner or seller does not give you a loan but gives you credit, minus any down payment which you may need to make just as in the case of bank loan. Every month you make a payment to the owner, to pay off the interest and the principal.

A promissory note is signed, where all details of the transaction like the loan amount, interest rate, term of the loan, the schedule for repayment and other conditions are mentioned. The house remains in the name of the owner. As soon as you clear the loan, it is transferred to your name. 

Terms and conditions

Generally, in owner financing, a down payment of anywhere between 5-25% of the home value would be expected. On an average, you may have to budget at least 20% as down payment and keep the money on hand.

Banks usually give you a loan amortized for a period of 30 years. But in owner financing, a seller may not be ready to wait for such a long period to get his money. They usually insist on a 15 year period or maximum of 20 years.

You may be asked to pay a balloon payment after 10 years (for a 15-year term), which means that after 10 years, you have a lumpsum amount equalling the balance. 

Advantages of owner financing

The main advantage of owner financing is the process is faster, unlike bank loans where there are a lot of procedures to be followed. Down payment, as well as monthly payments, can be negotiated since you are dealing with an individual and not an institution. If for any reason, like a low credit score, you can’t get a loan from the bank, then this is a very advantageous option. For the seller, the benefit is ownership remains with him till the end of the loan term and he can also get a higher interest rate. 

Limitations of owner financing

For the buyer, the interest rate would be higher as compared to a bank. Also, you may need to pay a large amount as a balloon payment. If you don’t have the cash at that time, you may have to borrow again. For the seller, the risk is that if the buyer doesn’t pay, then the legal process has to be initiated to recover the amount and make him vacate the house.

Owner financing is a good option for home buyers, who can pay monthly payments directly to the seller instead of dealing with the bank. It is a more flexible arrangement and avoids all the hassles and cumbersome procedures that you encounter with bank loans.

Related Articles