What is Owner Financing?

A friend sent me an email last night asking me about owner financing. I’ve had quite a bit of experience with owner financing, but it made me realize that most buyers and sellers probably have not. Here are the basics:

Owner financing is when the seller of the property also acts as a lender for the buyer. In essence, the seller becomes Fidelity Bank or Bank of America or whoever you were going to borrow money from to purchase the home. Instead of or in addition to getting a traditional loan, the seller lends you the money out of their proceeds. However, the title of the property is transferred to the new buyer, so the only interest the old seller has once the property is sold is that of the lender. They no longer have any ownership, so the buyer has all the same rights as they would if they used traditional financing.

When sellers do this, they can either be the sole lender or they may lend a 2nd mortgage that is in addition to a traditional loan. Typically, sellers can only be the sole lender if they own the property out right (i.e. they do not have a mortgage). If they have a mortgage, most mortgages have a “due on sale” clause that their current lender can exercise if the property is sold. Since we said that in an owner financing situation, the property is truly sold to the new buyer, then the old mortgage lender could call the rest of the mortgage due at this point. That would require the seller to pay off the existing mortgage in one payment. That can be a problem for most sellers. Of course, if the seller does not have a mortgage, then they can finance the purchase for the buyer instead of getting all of their proceeds in cash at the closing. If the seller is lending a 2nd mortgage, the buyer’s down payment and 1st mortgage may be enough to pay off their existing loan, so they just make the loan out of their proceeds.

It may be easier to see with some numbers, so let’s compare three situations in which a buyer is going to purchase a house for $300,000 and needs to make a $60,000 down payment.

1. Conventional Financing. The buyer goes to Fidelity Bank and gets a loan for $240,000 to cover the difference between their down payment and the purchase price. The seller’s proceeds at closing are $300,000 minus closing costs, commissions, and any mortgages.

2. Seller Financing – The buyer makes a $60,000 down payment to the seller, and the seller lends them $240,000 to be paid back at agreed upon terms over an agreed upon length of time. Like everything in real estate, those terms are negotiable. This time, the seller’s proceeds at closing are $60,000 minus closing costs, commissions, and any mortgages.

3.Seller 2nd Mortgage Financing – The buyer makes a $30,000 (instead of $60,000) down payment and borrows $240,000 from Fidelity Bank. They need another $30,000 to close the transaction. In this case, the seller lends the additional $30,000. This time, the seller’s proceeds at closing are $270,000 minus closing costs, commissions, and any mortgages.

As you can see, the math adds up to $300,000 each time. What changes is from whom the buyer borrows the money and how and when the seller gets their proceeds. The seller is going to get $300,000 in both cases. However, in cases 2 and 3 they will be getting a portion of their proceeds back over time and with interest.

In the next post, we will examine the benefits of owner financing for the buyer and the seller.

Justin Landis
Keller Williams Peachtree Road

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