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How Does Owner Financing Work?

Posted by Early Growth

December 14, 2021    |     5-minute read (888 words)

Launching a new startup comes with many challenges. Location, however, can make your life simpler. If you are based in a business hub, you instantly have access to more clients, investors, and employable talent.

Purchasing a new home is the first order of business. If the prospect of taking out a bank mortgage isn’t for you, consider owner financing instead.

Owner-financed homes are an increasingly popular way of buying a residence. This post will discuss owner-financed land and homes.

What is Owner Financing?

Owner finance, or seller financing, is a method of purchasing real estate when you’re unable or unwilling to take out a traditional mortgage.

When you take out a standard mortgage from a bank, you borrow the money you need for the property and then pay the bank back over a fixed period with regular monthly payments. Owner-financed homes work slightly differently.

So, how does owner financing work?

Instead of dealing with a bank, you pay the owner directly in installments. A seller-financed mortgage works in roughly the same way. There’s a principal and interest to pay. You keep making monthly repayments until you cover the property’s purchase price.

The difference is there are no financial institutions involved.

You’ll still need to deal with a fair amount of paperwork to complete your owner financing contract, but it’s relatively straightforward if the seller accepts this method of financing.

Types of Owner Financing

There’s not just a single type of owner financing for homes. Other creative types of seller financing can overcome the challenges of purchasing a home.

Here are three types of financing that could work for you.

Seller-Held Financing

Seller-held financing essentially means that the property seller acts as the lender. They set the principal, the interest rate, and the loan terms. Both buyer and seller may choose to negotiate these three points.

Both short-term and long-term repayment plans are available with this financing option.

Junior Mortgage

Buyers who already have primary loans may also have a junior mortgage to complement them. For example, sellers may have a second mortgage that covers the difference between their initial mortgage and the purchase price.

For example, if a buyer already has a mortgage covering 70-80% of the home’s purchase price, they may take out an owner-financed junior mortgage to account for the remainder of the balance.

Lease-Purchase Option

These written agreements take place between the buyer and seller. A lease-purchase option gives a buyer time to save money, cover closing costs, or improve their credit.

Buyers usually pay a deposit and will lose it if their option to buy expires and they don’t leverage it.

The Pros and Cons of Owner Financing

Like any form of financing, the right option differs depending on your financial circumstances. Here are some advantages and drawbacks to signing an owner-financed contract.

Take note; this is from the perspective of the buyer, not the seller.

Pros

  • Faster closing times
  • Much lower closing costs
  • Down payment flexibility
  • Great if you can’t secure a traditional mortgage
Cons

  • Higher interest rates
  • Requires seller approval
  • The due-on-sale clause requires approval from the seller’s lender
  • Balloon payments after five to ten years
How to Buy a Home With Owner Financing

The process for buying a home with seller financing requires a few calculations and knowing where to look for your dream home.

Step One - Calculate Home Financing Payments

First, you need to know whether it’s a viable option. There are a few numbers you need to get started with:

  • Loan interest rate
  • Total loan amount
  • Number of payments
  • Loan term
Take the total loan amount and multiply it by the interest rate to get the final figure for how much you will be expected to pay in total. Divide that number by 12 to receive your monthly repayment.

Factor in how much equity you can build/save for when your balloon payment becomes due.

Step Two - Look for Owner Financing Homes for Sale

Start your home search by looking for buyers willing to enter into an owner finance contract. Many popular real estate search engines already have this filter in place, so you can easily look up properties.

If searching locally with realtors, you may need to approach the buyer directly to ask if they would be open to this type of selling agreement.

Step Three - Check the Property

You need to make sure that the seller either owns the home clearly or that their lender is willing to accept seller financing due to the due-on-sale clause.

Carry this out with the help of your attorney. Hiring an attorney is just as essential for managing the closing process as it is with any other type of home financing. With so many legal forms and checks to conduct, owner financing is not something you should tackle alone.

Conclusion

With so many ways to get financing for a home, it can be difficult to know where to turn. Owner-financed homes can also extend to apartment buildings and commercial properties for businesses.

If you need help managing the financial or legal sides of your business, turn to Early Growth. Let our experts support you every step of the way.

Contact Early Growth to learn more about how our experts support startups through our startup accounting services.

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