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Is Owner Financing A Good Idea? Pros and Cons

Certified Mortgage Advisor
NMLS 1701021
December 25, 2019

Owner financing, the pros and cons and everything in between

Is owner financing a good idea? So I was asked to give some pros and cons of owner financing. This is also called seller financing. So first of all, owner financing, and seller financing, they're both interchangeable. They're basically the same thing.

Loan through the owner

And what this means is instead of going through a regular lender with owner financing, you're having the seller of the property or the owner of the property. What they're going to do is they're going to function as the bank. So instead of getting a loan through a lender or a bank or a credit union or a broker, you're going to get a loan through the owner, they're going to provide financing.

So they might own the house in cash, and then they're giving it to you through a loan that they give, or they might have their own mortgage. And then you're double mortgaged on that property. The owner has a mortgage and do you have a mortgage? And it can get a little risky.

Why should we choice owner or seller financing?

So the reason you would want to do owner financing or seller finance, Is because you might not be able to qualify for a traditional mortgage.

Traditional mortgage

A traditional mortgage is going to be a lot cheaper and safer over a long period of time, but they're a little tighter to qualify for it. They're a little more difficult to qualify for.

Terms is up to the owner

For owner financing, those terms are completely up to the owner. They can lend out money to whoever they want to because there are no regulations that dictate owner financing, except things like, owners can't discriminate in their lending.

Pros and Cons

Let's explore a little bit of what this looks like. Some pros and cons. Is it going to be a little bit dense, but hopefully this should clear it up for you. If you want to do owner financing. So let's first talk about some pros. Why would you want to do owner financing in the first place?

Pros 1: Faster closing

You're not going to have to worry about the normal 30-day process that it takes to close a loan. You don't have to worry about coordinating a seller selling the house and appraisals and inspections and going through the loan process. None of that matters it's just through the owner. So if they want to give you the loan and start it next week, they can do that.

Pros 2: Cheaper closing

So the owner won't necessarily charge fees as you would normally experience in a regular mortgage, so you probably won't have appraisal costs. You probably won't have any underwriting fees.

You probably won't have title fees. Those were probably already paid by the owner when they got the property to begin with, but in exchange for cheaper upfront, You're going to notice that it's more expensive in the long run and what's happening here is, owner financing sometimes functions more like renting than actually owning and we'll get into that.

Pros 3: Super flexible

Also super flexible. So this is big. There are no government minimums. There are no federal guidelines. That means that if the owner says, they're willing to give you money, great, they'll give you money. They might run a credit check or they might ask for some documents, but most of the time that doesn't happen. They might just want a couple of things to see if they're your somebody that they want to lend to.

And most of the time, these situations are If they know you, they have a history with you. Then they're more willing to give you money. It's very difficult to find just a random stranger to do owner financing because it's very risky for the owner.

Pros 4: Good if you can quality

So this is good if you can't qualify. But overall it's just an okay strategy. This is a good short-term solution. I would argue that renting is probably better than owner financing just because there are some risks to it. But we can talk about a little bit that with the cons as well.

Cons 1: High interest

So with a land contract, that's a one type of owner financing or any other type of owner financing. You're going to see those interest rates probably be double to triple the average interest rate on a mortgage on a traditional mortgage. So if interest rates right now, for instance in the market that we're in right now, interest rates are hovering around 3.5% on average is what I'm seeing in my pipeline with my clients.

Refinances that I'm looking at to do with people who are inland contracts. I'm seeing anywhere between eight and 10% interest rates. So something to be careful of is a short-term strategy owner financing should not be a long-term strategy.

Cons 2: Difficult to find

Also, it's going to be very difficult to find. You need to look for special offers or connections. So most of the time, people don't want to give out money to other people who can't qualify for a regular mortgage, why? They got turned down for a regular mortgage because they are a risky buyer. And that means they're probably going to be a risky buyer for the owner.

Individuals don't want to lend out that much money if they feel like they're not going to get that money back. So what you might have to do is be on the lookout for anything that says owner financing or seller financing. They're hard to come by, but they do exist. Also, there are quite a few realtors who will actually do owner financing on their own because they want to get properties moved or they already know you. So they have a history and are willing to lend you money because they know you.

Cons 3: Owner responsibility

So what's happening is you're having two mortgages stacked on top of each other. So sometimes the owner of the home either has their home paid in full. And then you have less chance of them getting foreclosed on. Maybe if they don't pay their taxes, but what often happens with owner financing is the owner themselves has a mortgage. And then what they do is they offer you a mortgage on top of that mortgage. So you're both paying down a mortgage on these properties.

And what's risky about that is if the owner decides to pocket your money, but not pay their mortgage, that mortgage gets foreclosed on. So does yours. So that's just something to look out for if you are going through with that solution, you want to see how is this actually being set up. Is the money that the home is secured with is it against the property or is it clear.

Cons 4: Balloon payments

Balloon payments are something that you need to watch out for. Most things like a land contract have an expiration date, meaning that they'll say at a certain date and time you have to purchase the property or move out, and sometimes moving out means you get no equity from it.

So that's, what's called a balloon payment. That means that the mortgage is actually short-term. It might amortize over 30 years, meaning the payment looks like a 30-year mortgage. The balloon is for five, meaning that it expires in five years and you need to either buy it in cash, a refinance with a traditional mortgage or move out of the property.

Cons 5: Does not record on credit

So this does not help your credit score, and this is a really big one because if you're going with owner financing, your credit, probably isn't the greatest meaning that you need. That's probably why, if you're looking at owner financing, you might not be able to qualify for a regular mortgage because maybe your credit needs some work having on-time payments record on your credit report is wildly beneficial to increasing your score. So if you go with owner financing and it's not recording on your credit report, then it's not helping you at all. It's not helping you build your credit.

Now renting most of the time doesn't show up on your credit report. Sometimes it does. Sometimes you can find rental companies who will put rent payments on your credit report, but it's not helping you at all by not being on your credit report.

Cons 6: The owner might not record it with the county

This means that you have no true ownership of the property. This is the biggest one that I actually see quite a lot. People think that they own the home. They think that they're on the title of the property, but the owner never records the land contract or whatever contract they're using for owner financing with the county. And so they're never put on a title, meaning they never have ownership of the property.

I have a couple of land contracts I'm working with right now where we can't even refinance them because they're not on this title. They have to go through with a purchase, which makes it a lot more difficult and a lot of extra layers in there.

What to look for?

So if you are going to go through with owner financing, first of all, check and make sure that you have options to look for a regular mortgage, you're going to save so much money by going with a traditional mortgage, even though it's a little bit more complex.

Make sure you're calling around with local lenders, and find which ones are going to give you some advice. Maybe you're just in a six-month game plan or even a year-long game plan. Maybe it's only a month-long game plan to get you to be able to qualify for a regular mortgage. Make sure you find all those options first before you get into something costly like owner financing. But if you do go with owner financing, what do you want to look for?

Don't worry about the rate

The rate does not matter because this is a short-term strategy. I like to call this the bridge. And what's happening in the bridge is you're going from something owner financing, like a land contract. And you're going to be in this land contract for a few years. So let's say maybe three years, and maybe in that three years, you're working on building up your credit. Maybe your credit started out at 500 and now your credit is up to a 640. So then you take your land contract and refinance it into something like an FHA or a conventional loan.

So all you're doing with that land contract is you're just using it. You're just using the owner financing to build equity, pay down a mortgage, and then refinance into a better lower-cost loan in the future. So don't worry about the rate. It's going to be high, no matter what, even if it's upwards of eight, 10% I would, that's what I would expect for a land contract. It's just risky, that's why you need to find other types of money first, like a traditional mortgage, and then look at owner financing.

Focus on dangerous features

So instead of worrying about the rate, focus on dangerous features. Make sure, we do not want it to be interest only. Interest-only is a dangerous feature. It's not paying down the principal of your mortgage. Watch out for balloon payments. So when does that contract expire? Look out for not being recorded on the title, make sure that you have ownership of that property. Then watch out for any other terms that allude to fees or costs in the future. For instance, how much of your payment is going to go towards the principal? Are you going to get any type of money back towards a down payment if you purchase the property if you refinance the property?

Look at those terms. Look for the dangerous features instead of the rate. So you're going to want to stay within your long-term budget. That's the biggest thing you need to watch out for consult your budget. First, if you can only afford a thousand dollars. Don't go into a land contract. That's $1,200 per month.

Have an exit strategy

Then finally have an exit strategy. Again, this is all about a bridge you're using the land contract. Then refinancing into a better deal. So the whole time you're in a land contract, you need to be planning the next steps. Because that land contract max should be about three to five years for you before you refinance into something else or you move out and you purchase something else. So you now have three to five years as a window to do work.

So this means working on your credit, working on your income, building up savings, those are all things that you have that you need to do in that three to five year window.

Talk to experts

And the way that you can figure out what you need to do if you're not sure is to consult a mortgage advisor and a credit repair specialist, the mortgage advisor is going to see where you're at and tell you what you need to change to qualify for a regular mortgage. And the credit repair specialist is going to be someone who's going to give you advice on how to build your credit up in the future.

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Kyle Andrew Seagraves is Federal Mortgage Loan Originator (NMLS 1701021) licensed in all 50 states with the Dan Frio Team at Allied First Bank (NMLS 203463), an Equal Housing Lender. Separately, Kyle owns Win The House You Love LLC, an education company. Win The House You Love LLC is not a lender, does not issue loan qualifications, and does not extend credit of any kind. This website is only for educational usage. All calculations should be verified independently. This website is not an offer to lend and should not directly be used to make decisions on home offers, purchasing decisions, nor loan selections. Not guaranteed to provide accurate results, imply lending terms, qualification amounts, nor real estate advice. Seek counsel from a licensed real estate agent, loan originator, financial planner, accountant, and/or attorney for real estate, legal, and/or financial advice.

Servbank is not affiliated with the VA, FHA or any other government agency. This site has not been approved by any government agency.
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