The Investor’s Guide to Seller Financing: What Is Owner Financing & How Does Work?

The Big Picture On Owner Financing:

Owner financing means the person selling the home lends money to the buyer instead of the buyer getting a traditional bank loan.
Buyers can find homes with owner financing by looking at listings online, talking to real estate agents, and reaching out to people who own property
Investors who buy homes to rent out might like owner financing because they don’t need as much money upfront, but they should think carefully about their money situation.

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Low-interest rates and stock market uncertainty have set the real estate market sizzling in most of the US. With borrowers flooding lenders to take advantage of those low rates and lingering economic weakness in the wake of the coronavirus pandemic, many lenders have tightened their loan standards.

This has left many homebuyers and real estate investors struggling to find financing. But do you really have to go through a bank or traditional lender?

Enter: owner financing.

What Is Owner Financing?

Owner financing, also known as seller financing, occurs when the person selling the home finances the purchase for the buyer. The seller lends the mortgage to the buyer, who pays it back in monthly installments like a bank mortgage.

It could replace the first mortgage entirely, cutting the bank out of the equation. Or the seller could lend a second mortgage on top of a bank’s first mortgage. Known as a seller-held second, the seller takes a second lien position after the bank’s first mortgage lien.

When the seller acts as a bank or mortgage lender, it eliminates the risk of the buyer’s financing falling through. However, the seller also assumes the risk of the borrower defaulting.

How Does Owner Financing Work?

It happens constantly: the buyer struggles to find adequate financing, jeopardizing the contract. Rather than let the deal fall through, the seller will agree to lend the buyer either a first or second mortgage.

In the case of a second mortgage, the seller lends some or all of the down payment. That minimizes the down payment the buyer has to come up with the agreement, and the buyer then makes payments to the bank and the seller. This arrangement proves particularly helpful to buyers with solid incomes who lack the cash to put 20% down and potentially even let them buy a property with no money down.

However they go about it, the buyer will have to pay the loan back to the seller at an agreed-upon rate.

Common Types of Seller Financing

Below are the types of seller financing agreements that you can encounter in this real estate investment.

Type of Seller Financing

Description

Deed of Trust

The seller carries a traditional mortgage for the buyer. The seller’s mortgage is usually recorded with the county.

Land Contract

The seller retains legal title while the buyer makes payments. Once payments are completed, the seller transfers the legal title.

Rent-to-Own

The buyer leases the property with the option to purchase it at a predetermined price with a promissory note. A portion of the rent may be applied to the purchase price.

Wraparound Mortgage

The seller keeps their existing mortgage and sells the property to the buyer. The buyer makes payments to the seller, who continues paying their underlying mortgage.

Second Mortgage

The buyer obtains a first mortgage from a lender, and the seller provides a second mortgage. The seller’s second mortgage is subordinate to the first.

Assumable Mortgage

The buyer takes over the seller’s existing mortgage. The buyer may make separate payments to the seller for the balance.

Balloon Payment

The seller finances the purchase for a shorter term with a larger lump sum payment due at the end. The buyer is expected to refinance or sell before the balloon payment is due.

Seller Financing Loan Terms

The loan terms are entirely negotiable between the two parties. Interest rate, points, loan term: the buyer and seller can work out any arrangement they like.

Most sellers don’t want to hold a mortgage for the next 15-30 years, so they typically issue the loan with a balloon term, which is generally a 5 to 10-year contract. The monthly payments may be amortized like a 30-year mortgage, but the seller imposes a shorter time limit to repay them in full.

The buyer can make monthly payments like a standard 30-year mortgage for those first five years, but then they have to either refinance the mortgage to pay the remaining balance off in full, sell the property, or pay it off early out of their pocket.

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Advantages of Seller Financing

Owner financing offers perks for both the buyer and seller. Consider the following benefits as you explore seller financing on either side of the transaction.

For the Seller

Passive Income & Cash Flow: If the buyer reliably pays on time, the seller benefits from consistent cash flow—both from interest and principal—that can be used towards other investments.
Higher Interest: You can often secure a higher interest rate than you can expect on the market for what you own, so your money will work harder and more efficiently without you having to do any extra work in the form of cash flow.
No Landlord Headaches: The seller doesn’t have to manage tenants, fix toilets, or hassle with contractors. They just collect their payment each month.
Quicker Sale: If you are having trouble finding a buyer, giving the option of seller financing may entice potential suitors. While a slimmer advantage in a seller’s market, such as today’s, it still allows more flexibility.
Collateral: You can foreclose to return the property if the buyer defaults on their monthly payments.

For the Buyer

Low or No Down Payment: Buyers can potentially secure a larger loan from the seller than they might from a bank. Or you could negotiate a second mortgage as a creative way to come up with a down payment. You may not have to come up with a down payment at all, depending on the financing arrangement.
Avoid PMI: If you take out a conventional mortgage and borrow over 80% LTV (loan-to-value ratio, or the percentage of the property value you borrow), you’ll have to pay PMI each month. Short for private mortgage insurance, the insurance covers your lender against default – it doesn’t protect you in the slightest and is effectively lost money. By using seller financing, either for your first or second mortgage, you can avoid PMI.
More Room for Negotiation: Banks aren’t known for their flexibility. However, you can negotiate lower fees and interest rates when you borrow a mortgage from the seller.

Drawbacks to Seller Financing

While owner financing has plenty of perks, it has risks and downsides, just like traditional financing. Make sure you weigh the pros and cons before committing!

For Sellers

Risk of Default: Sellers generally have less deep pockets than banks. This means they are taking on the risk of lending money as individuals rather than institutions—and without the systems to qualify and underwrite borrowers.
Expensive, Lengthy Foreclosure Process to Enforce Loan: If the buyer defaults on payments, they may just walk away from the home, but if they don’t, the seller will be responsible for going through the foreclosure process. This can be a time-consuming, expensive task.
Existing Mortgage Still Due in Full: If you still hold a mortgage, you must pay it off upon selling the property.
Complicated Taxes: Tax payments based on the sale can be complex and will likely require the assistance of a CPA. There are tax benefits that can be had, but it can take quite a bit of time to work them out.

For Buyers

Higher Interest Rates: Because sellers don’t have the bank’s financial backing, such as credit scores or business income, they might hold out for a higher interest rate based on the risk they are taking.
Risk: Take note that it is not only the seller who takes on more risk. The buyer can also make a risky choice, especially if a balloon payment is due within five years. If the buyer can’t pay by the due date, they could face foreclosure and lose the property.
Fickle Approval: Sellers don’t follow the rules and regulations of the banking industry and can decide not to lend to you for various reasons. If you are rejected for a bank loan, you will at least know why—a seller doesn’t necessarily have to provide an explanation.

How To Find Owner-Financed Homes?

Lack of mortgage approval can hold you back to finally becoming a homeowner. However, there’s a whole world of possibilities beyond the bank. Owner-financed homes can be an option, but how do you find these? 

Real Estate Listings

Many home sellers are upfront about offering owner financing. You can find these while browsing popular real estate websites like Zillow, Redfin, or Realtor.com. For example, you can scan listing descriptions for terms like “owner financing,” “seller financing,” or “rent-to-own.” 

Real Estate Agents

Newbie real estate investors often underestimate the power of a good real estate agent—thou shalt not. Look for one who specializes in owner-financed properties. They may have access to listings with this type of financing that haven’t been advertised yet. Moreover, experienced agents often know sellers who might be open to owner financing—even if they haven’t mentioned it.

Online Marketplaces

Online platforms like Craigslist, Facebook Marketplace, or For Sale By Owner (FSBO) are suitable spots when looking for properties. Here, you’re more likely to encounter sellers who might be willing to finance the sale themselves, especially if they haven’t attracted traditional buyers.

Wholesalers

Real estate wholesalers are like middlemen—wholesalers find below-market properties and resell them. Sometimes, these properties come with the option of owner financing. You can connect with wholesalers by attending local real estate investor meetups or by joining online groups about real estate investing in a particular area. 

Attorneys or Title Companies

You can also utilize attorneys and title companies in real estate transactions. They might come across old or new properties where owner financing is possible during their work. This is no easy task, but building a relationship with them could lead you to properties that suit your needs.

Direct Mail Campaigns

You can reach out to property owners interested in owner financing with direct email campaigns – just be creative with your email, as these folks receive tons of it now and then.

Focus on absentee owners looking to offload a property, those with delinquent taxes who could benefit from a quick sale, or even owners with free and clear properties (without mortgage liens).

In your message, highlight the advantages of owner financing for them, like faster sales or a guaranteed income stream through your monthly payments.

Networking

Networking can make a difference for investors in any field. Try attending local real estate events, joining investor groups, or simply striking up conversations with other investors. These interactions can open doors to information about properties that haven’t hit the traditional market yet. And hey, sellers might be more open to owner financing when dealing with someone they’ve met through these connections. 

Advertise

The old saying goes, “Don’t wait for the opportunity to find you; go get it!” You can place ads on Craigslist, Facebook Marketplace, or local newspapers. However, you must clearly state that you’re seeking owner-financed properties. This approach lets motivated sellers open to owner financing find you directly.

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Sample Seller Financing Deal

To help you understand more about seller financing, consider the sample deal below.

In this example, the home price in 2023 is $500,000, and the buyer can put a down payment of $100,000 (20%) but has only been approved for a loan of $350,000 for a traditional mortgage. This means that the seller will have to finance the additional $50,000 for the cost of the house. 

Investing Terms

Traditional Mortgage

Seller Financed Mortgage

Loan Amount

$350,000

$50,000

Down Payment

20%

0% to 10%, but can vary

Interest Rate

2.85%

6%

Term

30-year mortgage

10 Years

Monthly Payment

$2,386

$740

As you can see, there are two legally binding payments, one to the bank for $2,386 and one to the seller for $740, for a total monthly payment of $3,126. That might seem high, but keep in mind that the seller and buyer agreed to a 6% interest rate on the $50,000 loan.

It’s possible that this could be negotiated to a lower rate, but a seller-financed loan will rarely have a lower interest rate than one from the bank.

Considerations for Landlords and Investors

If you are looking to buy a home as an investment property, seller financing can benefit you by limiting the amount of cash you have to part with upfront. If you can negotiate a lower down payment, you might be able to make up for the higher interest rate in rental revenue.

In a multifamily property, you can house hack to have your tenants pay for your mortgage. House hacking allows you to essentially live for free and gain monthly equity in the property. With your higher savings rate, you can pay off a seller-held second quickly or even pay off your first mortgage.

If you are flush with cash and can afford to put a substantial down payment on a house, considering seller financing might not make sense. You’ll benefit from lower interest rates and monthly payments if you go the traditional route, but you must come up with more cash upfront.

FAQs

What is Private Financing?

Private financing involves private loans not underwritten by mortgage lenders or sold on the secondary market. The loan process differs from traditional lending.

What are the Benefits of Private Financing?

The benefits of private financing are accessibility, flexibility, and faster approval compared to traditional loans.

How Does Owner Financing Work in Texas?

Owner financing in Texas works by making a down payment and paying off the remaining balance over time. It is typically more expensive and requires refinancing into a traditional loan within five years.

Who Holds the Deed in Owner Financing in Florida?

In owner financing in Florida, the seller holds the deed until the buyer makes the final payment.

In What State Is Owner Financing Most Common?

Texas has the most owner financing and has a count of 20,922

What is the Average Origination Fee for Owner-financed Mortgages?

The average origination fee for owner-financed mortgages is typically 0.5% to 1% of the loan amount. 

What are the Typical Loan-to-Value Ratios Required for Owner Financing?

The typical loan-to-value ratio required for owner financing is 80% or less. Anything above 80% may lead to higher costs or being denied financing.

Final Thoughts

There is no universal right or wrong answer regarding financing. There are various factors at play if you go this route, and you’ll have to evaluate your current financial situation and your plans for the future. Even if seller financing is not currently on your radar, it’s nice to know that it is a viable option for potential investment properties. 

Have you ever borrowed owner financing? What were your experiences with it?

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