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Owner financing is a type of funding that allows owners to invest in their business and earn equity. The most common type of owner financing is seller financing, which lets the business’s owner sell some or all of his ownership stake back to the company for cash before an offering (or on sale) so as not to dilute its stock value.
Instead of having the buyer acquire a loan from a bank, the seller offers to take installment payments directly from the buyer. Owner finance, also known as Financing from the seller, offers purchasers simpler qualifying and more flexible payback terms than a typical mortgage while also delivering monthly revenue to sellers.
What Financing from the owner Is & How It Works
When a typical mortgage is unavailable, Financing from the owner (also known as Financing from the seller) may be utilized to acquire real estate. A standard mortgage entails borrowing money from a bank to pay for the property and repaying the debt to the bank. A direct financing deal with the seller is known as Financing from the owner. You agree to pay the owner in installments, usually of principle and interest, until the property’s purchase price is paid in full.
Anyone may utilize Financing from the owner for any sort of property, from a single-family house to an apartment complex or even a plot of undeveloped land. An owner-financed transaction requires the completion of legal documents such as promissory notes, mortgages, and trust deeds. This documentation is common; more importantly, it protects all parties involved.
Any of the following words may be used to describe Financing from the owner:
- Financing from the owner
- Financing from the seller
- Financing provided by the owner.
- Carryback by the owner
These are all terms that indicate that the owner is providing financing. In various regions across the country, you may find that Financing from the seller is referred to by one or more of these terms.
An Example of Financing from the seller
Let’s imagine you’ve identified a $100,000 investment property that is completely owned by the seller. You could go to the bank and get a typical mortgage for a portion or all of the $100,000. However, it’s possible that your credit isn’t perfect, that your self-employment income is difficult to verify, or that you’ve already taken out numerous investment mortgages and have exhausted your borrowing capacity. Your bank has turned you down for a mortgage for whatever reason.
In this case, you could approach the seller and ask if they would consider Financing from the owner of your purchase. Instead of buying the property for cash or from the proceeds of a bank loan, you will make monthly installments directly to the seller. Per the agreement between you and the seller, these installments will include principal and 7% interest over a typical 30-year term.
Typical Financing from the owner Terms
The repayment terms for Financing from the owner agreement are not typically as straightforward as the example given above. In reality, you’ll probably need a Making a Down Payment, the seller will likely want the loan repaid within a shorter term and may require a Payment via Balloon at the end of the loan.
The terms for Financing from the seller agreement may include Making a Down Payment, Amortization of loans, Payment via Balloon, and more realistic Financing from the owner terms.
Making a Down Payment
Like most traditional lenders, sellers offering Financing from the owner will likely require you to provide a Making a Down Payment. To the seller, a Making a Down Payment is your “skin in the game.” It’s what you stand to lose if you default on the loan. You can expect sellers to require a Making a Down Payment of 5% to 25% or more of the loan amount. While a seller may ask for a Making a Down Payment, there’s often room for negotiation.
Amortization of loans
Standard mortgages have a 30-year amortization, which is what most borrowers expect when seeking real estate financing. With Financing from the owner, sellers will typically want shorter repayment terms, so that they can receive the payment from the sale of their real estate faster. While a 30-year amortization schedule is possible, expect the loan to be wrapped up earlier with a Payment via Balloon or a straight amortization of more than 15 to 20 years.
Payment via Balloon
With a Payment via Balloon, the full amount of the principal is not repaid during the loan term resulting in a lump sum payment due at the end of the loan. For example, if the seller is willing to commit to Financing from the owner but does not want to have the loan be in repayment for 30 years, they may offer a shorter repayment term that culminates in a Payment via Balloon at the end of the term. As such, the seller may offer you a 15-year mortgage based on a 30-year amortization. This would result in lower monthly payments for 15 years but would require a sizable Payment via Balloon at the end of year 15.
Typical Financing from the owner Documents
To set up an agreement for Financing from the owner, either you or the seller will need to have two forms of paperwork. One is called a promissory note, which spells out the loan terms and expectations for repayment. The other will be either a mortgage document or something called a deed of trust, which provides security for the loan.
Promissory Notes
Promissory Notes are notes used that are not difficult to understand. They are your promise to repay the debt and include the following information about the agreement:
- Debt to income ratio
- Repayment period
- The rate of interest
- The plan of repayment
- Payment frequency, such as monthly or quarterly
- The amount of the payment, as well as whether it is principle and interest or another kind of payment
- Whether a Payment via Balloon is involved and what those specifics are
Promissory Notes will detail the penalties for late payments, any prepayment penalties, and whether the loan balance may be due in full if you sell the property (called a due-on-sale clause). Either you or the seller can hire an attorney to draft the promissory note and other documents, or you can use an online legal service.
Deeds of Trust and Mortgages
These two papers serve the same purpose; which one is utilized depends mostly on where you are purchasing and what the standard form is in that region.
The seller is protected by both mortgage paperwork and deeds of trust. In essence, they put a lien on the property and provide you with recourse if you don’t pay your bills. They are filed at the local courthouse to guarantee that there is a legal record of the lien, expectation of repayment, and give the foundation for foreclosing if required, which is important to the seller. If the owner has to repossess the property, the procedure of foreclosure is outlined and differs depending on whether a mortgage or deed of trust is employed.
Potential Complications With Financing from the seller
Financing from the owner was a common form of real estate financing; however, changes in lending practices related to existing mortgages and legislation following the Great Recession known as the Dodd-Frank Wall Street Reform and Consumer Protection Act have complicated the Financing from the owner process.
Current loan on the Property
One of the most common questions raised—and one of the most difficult situations to wrestle within an owner-financed deal—is what to do if, On the property, there is a current loan.
Many existing mortgages were assumable a few decades ago, which meant that a buyer may take over the duty to pay on an existing mortgage. In fact, the buyer would take over as the new loan payor. With owner-financed transactions, this worked very well.
Most mortgages now contain a due-on-sale clause, which renders them unassumable since any leftover loan debt must be paid in full at the time of sale, with very few exceptions.
When the property has an underlying debt, there are a few methods to get around the due-on-sale provision and still set up an owner-financed contract. All of them fall within the category of unconventional funding. If there is an existing mortgage, we urge that you get legal advice before using any of these strategies.
1. Purchasing a home subject to an existing loan
This isn’t dissimilar to taking on a mortgage. Unlike an assumption, however, the original holder remains legally liable for the payments. If you don’t make your payment to the seller, they are still accountable for paying the original lender on the loan. Only a small percentage of vendors will consent to this.
2. Wraparound Mortgage
A wraparound mortgage creates one loan that is big enough to pay on the existing loan plus any additional equity in the property. With a “wrap” mortgage, you make this larger payment to the seller. In turn, you entrust the seller to pay the underlying mortgage. The difference between the two is the Financing from the owner on the equity. However, as the buyer, you may be held responsible if the seller doesn’t pay their underlying loan.
3. A Trust Deed that Covers Everything
A wraparound mortgage is an all-inclusive trust deed. It’s a legal phrase that numerous states use to describe the same thing.
4. Lease Purchase or Lease Option
With this strategy, you lease the property from the seller with the option to purchase, or you already have a contract in place to buy the property at a later date. This gives you ownership over the property and its sale price until you can get outside funding. Buyers should be cautious if the seller defaults on their payments while the leasing option is active.
5. Contract for the Purchase of Land
This is, without a doubt, the most difficult kind of innovative funding. A contract is set up for the buyer to make specified installments over a period of time, usually five to ten years. It permits the buyer to keep control of the property and price until additional financing can be obtained, similar to a lease option.
The actual danger with a “land contract” is that the buyer has no vested interest in the property’s title. If they miss even one payment, the contract is automatically canceled, and the seller receives the property without having to foreclose.
The Dodd-Frank Act
In the aftermath of the subprime mortgage meltdown and the predatory loans that had been issued prior to 2007, Congress enacted legislation known as the Dodd-Frank Act. This act was aimed at Wall Street, but politics allowed its scope to also blanket private sellers who offer Financing from the owner.
The details are beyond the scope of this article, but for the average seller, with a property or two for sale, the Dodd-Frank is of no real concern. It’s not until a person is attempting to sell three or more properties with Financing from the owner that Dodd-Frank applies. Among other expectations, the seller will need to obtain a mortgage originator’s license. For this reason, Financing from the owner has become more difficult to obtain.
Advantages & Disadvantages of Financing from the owner
Financing from the seller offers benefits to both the purchaser and seller. Still, there are some pitfalls to be aware of.
Here is a list of each party’s advantages and disadvantages.
Benefits to the Buyer
- Qualification is simpler.
- Rates and conditions may be negotiated.
- Closing expenses are reduced
- Closing more quickly
Disadvantages for Buyers
- It’s possible that sellers may refuse to carry financing.
- The flexibility of Financing from the owner may come with a price tag
- If there are underlying mortgages, it will be difficult.
Advantages of the Seller
- Can expedite the sale of a property
- Can get a better deal
- Interest revenue is generated on a monthly basis.
- If the property is foreclosed on, you may be able to reclaim it.
Disadvantages for the seller
- Don’t expect to get paid in full right away.
- Payment collection issues
- Can result in foreclosure.
- The loan must be administered by the sellers.
- Owner-occupied mortgages were restricted by the Dodd-Frank Act.
Conclusion
Financing from the owner is a financial arrangement in which buyers make payments directly to the seller rather than acquire a mortgage from a financial institution. Payments are usually in the form of monthly installments of principal and interest. Sellers benefit by getting monthly interest income along with a potentially higher selling price and a quicker sale.
