Owner financing is an arrangement in which the seller agrees to accept installment payments directly from the buyer rather than having the buyer obtain a loan from a bank. Owner financing—sometimes referred to as seller financing—often provides buyers with easier qualification and more flexible repayment terms than a traditional mortgage while providing sellers with monthly income.
What Owner Financing Is & How It Works
Owner financing—also called seller financing—can be used to purchase real estate when you can’t obtain a traditional mortgage. With a traditional mortgage, you borrow money from a bank to pay for the property and make payments back to the bank to pay off the loan. Owner financing is a financing agreement made directly with the seller. You make arrangements to pay the owner in installments, typically of principal and interest, until you’ve paid off the purchase price of the property.
Owner financing can be used by anyone, and for any type of property from a single-family home to an apartment building or even piece of raw land. An owner financed transaction requires a certain amount of legal paperwork, including promissory notes, mortgages, and trust deeds. This paperwork is fairly standard; more important, it protects everyone involved.
Owner financing may be referred to by any of the following terms:
- Owner financing
- Seller financing
- Owner carried financing
- Owner carryback
- Owner will carry (OWC)
These are all terms that indicate that the owner is providing financing. In various regions across the country, you may find that seller financing is referred to by one or more of these terms.
An Example of Seller Financing
Let’s say you’ve found a $100,000 investment property that the seller owns outright. You could go to the bank and borrow some or all of that $100,000 through a traditional mortgage. However, maybe your credit isn’t stellar, your self-employment income is difficult to verify, or you already have several investment mortgages and have topped out what you can borrow. Whatever the reason, you’ve been denied a mortgage from your bank.
In this case, you could approach the seller and ask if they would consider owner financing 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.
Seller Financing Example
Number of Payments
360 (30 years worth of monthly payments)
Monthly Payment (Principal and Interest)
Total of All Payments to Seller
Typical Owner Financing Terms
The repayment terms for an owner financing agreement are not typically as straightforward as the example given above. In reality, you’ll probably need a down payment, the seller will likely want the loan repaid within a shorter term and may require a balloon payment at the end of the loan.
The terms for a seller financing agreement may include down payment, loan amortization, balloon payment, and more realistic owner financing terms.
Like most traditional lenders, sellers offering owner financing will likely require you to provide a down payment. To the seller, 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 down payment of 5% to 25% or more of the loan amount. While a seller may ask for a down payment, there’s often room for negotiation.
Standard mortgages have a 30-year amortization, which is what most borrowers expect when seeking real estate financing. With owner financing, 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 balloon payment or a straight amortization of more than 15 to 20 years.
With a balloon payment, 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 owner financing 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 balloon payment 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 balloon payment at the end of year 15.
More Realistic Owner Financing Terms
Let’s look at a more realistic owner financed scenario that involves both a down payment of 10%, a 30-year amortization period, but a balloon for the remaining balance due in year 15. Here’s what a balloon mortgage calculator shows.
More Realistic Seller Financing Example
Down Payment (10%)
30-year repayment schedule
At 15 years
Monthly Payment (principal and interest)
Balance Due at Time of Balloon
Total of All Payments to Seller (down payment + monthly payments for 15 years + balloon payment)
When the balloon comes due, you will either have to come up with $66,617 in cash to pay off the balance or refinance that amount to pay off the seller. By borrowing funds to pay the balloon payment, you will acquire a new loan and continue to have payments, despite paying off the loan to the seller.
Typical Owner Financing Documents
To set up an agreement for owner financing, 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 are not difficult to understand. They are your promise to repay the debt and include the following information about the agreement:
- Amount of debt
- Term of repayment
- Interest rate
- The repayment schedule
- Frequency of payments like monthly or quarterly
- Payment amount and whether it is principal and interest or takes another form
- Whether a balloon payment 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.
If you need a promissory note written, Rocket Lawyer is an online legal service provider that offers custom legal documents and offers additional legal assistance if needed.
Mortgages and Deeds of Trust
These two documents serve the same function; whether one is used over the other is mainly a function of where you are buying and what the customary form is in that area.
Both mortgage documents and deeds of trust provide security for the seller. In effect, they place a lien on the property and provide for remedies if you default on payments. Of importance to the seller, they are filed at the local courthouse to ensure there’s a legal record of the lien, expectation of repayment, and provide the basis for foreclosing if necessary. The method of foreclosure is specified and varies depending on whether a mortgage or deed of trust is used should the owner need to repossess the property.
Potential Complications With Seller Financing
Owner financing 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 owner financing process.
There’s an Existing Loan on the Property
One of the most common questions raised—and one of the most difficult situations to wrestle with in an owner-financed deal—is what to do if there’s an existing loan on the property.
A few decades ago, many existing mortgages were assumable, meaning a buyer could take over the obligation to pay on an existing mortgage. In effect, the buyer would become the new payor for that loan. This worked exceedingly well with owner-financed deals.
With very few exceptions, most mortgages today have what is called a due-on-sale clause, which makes them un-assumable because any remaining loan balance has to be paid in full at the time of sale.
There are some ways to try to subvert the due-on-sale clause and still set up an owner-financed deal when the property has an underlying loan. All of these get into the realm of creative financing. We recommend you obtain legal help if you attempt any of these techniques if there’s an existing mortgage present.
1. Buying ‘Subject to’ the Existing Loan
This is remotely similar to assuming a mortgage. However, unlike an assumption, the original holder is still legally responsible for the payments. If you don’t make your payment to the seller, they are still responsible for making the payment on the loan to the original lender. Very few sellers will agree 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 owner financing on the equity. However, as the buyer, you may be held responsible if the seller doesn’t pay their underlying loan.
3. All-inclusive Trust Deed
An all-inclusive trust deed is a wraparound mortgage. It’s a legal term used in many states to denote the same process.
4. Lease Option or Lease Purchase
With this approach, you lease the property from the seller with an option to buy, or a contract is already drawn up to buy, but at a later date. This allows you to control the property and selling price until you can arrange for outside financing. Again, buyers need to be wary in case the seller fails to make their payments while the lease option is in effect.
5. Land Installment Contract
This is, perhaps, the most complicated of all forms of creative financing. With this approach, a contract is set up for the buyer making stipulated payments for a period of time―five to 10 years is common. Similar to a lease option, it allows the buyer to control the property and price until other financing can be arranged.
The real caution is that with a “land contract,” the buyer has no vested interest in the title to the real estate. If they default on even one payment, the contract is terminated, and the seller gets the property back without any need to foreclose.
The Dodd-Frank Act Affects Owner Financing
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 owner financing.
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 owner financing that Dodd-Frank applies. Among other expectations, the seller will need to obtain a mortgage originator’s license. For this reason, owner financing has become more difficult to obtain.
Advantages & Disadvantages of Owner Financing
Seller financing offers benefits to both the purchaser and seller. Still, there are some pitfalls to be aware of.
Here is a list of the benefits and downsides for each party.
- Easier qualification
- Can negotiate rate and terms
- Lower closing costs
- Faster closing
- Sellers may be unwilling to carry financing
- The flexibility of owner financing may come with a price tag
- Difficulty if there are underlying mortgages
- Can get a property sold faster
- Can get a higher price
- Generates monthly interest income
- Can get the property back if it forecloses
- Don’t get all cash upfront
- Problems collecting payments
- Can end up in foreclosure
- Sellers have to administer the loan
- The Dodd-Frank Act placed limits on owner carried mortgages
Owner financing 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.