What Is Owner Financing & When Should You Consider It?
Tricia has nearly two decades of experience in commercial and federal government lending. Her expertise is highlighted throughout small business loan content on Fit Small Business.
Andrew has over a decade of experience in finance and mortgage lending. He shares his expertise in Fit Small Business’s financing content.
This article is part of a larger series on Business Financing.
Owner financing is where the property seller agrees to finance the purchase for the buyer. Instead of having the buyer make monthly payments to a lender, they would make payments to the property seller. Both parties must agree on the financing terms, such as the loan amount, interest rate, and amount and frequency of payments.
As a buyer, owner financing can be a good option if your credit or income does not meet a lender’s requirements. Sellers can also benefit, as it may help a property get sold more quickly or provide an additional source of income. However, rates may be higher for the buyer, and there could be complications for the seller if the buyer defaults on the loan.
Owner financing is also referred to by other terms, including seller financing, owner-carried financing, owner carryback, and owner will carry (OWC).
Types of Owner Financing
Many types of owner financing exist, each with varying payment structures and legal implications. Due to the complexity of this form of real estate financing, we recommend consulting with an attorney to ensure your interests are protected.
This is a common type of owner financing where the seller of a property acts as a lender for the buyer. The buyer and seller must agree on the specific terms, such as a loan amount, interest rate, when payments must be made, the amount of each payment, and how long payments must be made.
Once both parties sign the agreement, the buyer will make payments to the seller, who retains title to the property. Once the loan has been satisfied, the seller will transfer the title to the buyer. Holding mortgages typically are a form of short-term financing and are satisfied once the buyer can obtain another funding source.
This is a straightforward financing method in which a property buyer takes over the seller’s existing mortgage loan. The terms and conditions remain the same, including the interest rate and monthly payment amounts. Not all mortgages are assumable, and the current mortgage loan lender must also approve them.
One major benefit of an assumable mortgage is that it tends to be less expensive than a traditional mortgage. For example, the buyer will most likely not have to pay an appraisal fee and may get a lower interest rate than what other lenders currently offer for new loans.
Purchasing a property subject to an existing mortgage occurs when the seller remains legally responsible for the timeliness of the loan payments, but the payments are made by the buyer.
This is not a common form of financing because of the risks involved. If the buyer misses a payment, it will impact the seller’s credit rating negatively. However, it can be an inexpensive way to finance a home and help a seller finalize the home’s sale more quickly.
With a wraparound mortgage, the seller’s existing home loan stays in place. The buyer then takes on a private mortgage loan from the seller. When the buyer makes payments to the seller, the seller can use that amount to pay the lender.
In most cases, the seller charges the buyer a higher interest rate than the lender is charging them. As a result, they can profit from the difference in the interest rates.
With a lease-purchase agreement, the buyer makes payments to the property seller in exchange for the right to purchase the property later. It can be thought of as a rent-to-own arrangement, where the buyer has the exclusive right to purchase the property in the future.
Monthly payments can be counted as part of the buyer’s down payment. With this type of arrangement, the buyer will obtain equitable title to the property. Once they can get a mortgage or other type of financing to satisfy the balance owed, the seller will then transfer full legal title to the buyer.
With a land contract, a buyer makes payments to the seller for the right to use a piece of land. Once the loan balance is satisfied, full legal title transfers to the buyer.
Owner Financing vs. Traditional Loans
Owner financing and traditional bank loans typically have notable differences in loan characteristics. This includes funding speed, rates, fees, and other loan terms.
Traditional Bank Financing | Owner Financing | |
|---|---|---|
Interest Rate | 6% and up | 8% and up |
Loan Amount | Up to $5 million or more | Typically under $1 million |
Repayment Term | 30 to 35 years | Typically under 10 years |
Required Down Payment | 0% to 20% | 0% to 10%, but can vary |
Closing Costs | 1% to 3%+ of the loan amount | $250 (legal fees) to 1% of the loan amount |
Minimum Credit Score | 600+ | None, but can vary |
Required Debt Service Coverage Ratio (DSCR) | 1.25x | None, but can vary |
Funding Speed | Up to 30 to 60 days | Under 7 days |
As a buyer, owner financing tends to be more expensive than traditional bank loans. If you’re looking to cut down on costs and get approved at a lower rate from a bank, you can try some of the tips in our guide on how to get a small business loan.
When Should a Buyer Consider Owner Financing
As a buyer, you might want to consider owner financing if you cannot get a loan from a bank. This type of financing can also save you money upfront by eliminating many expenses associated with getting a mortgage from a bank, credit union, or other type of traditional lender.
Below are some additional circumstances in which you may find owner financing to be beneficial:
- You want to finalize the property purchase quickly: Purchasing a property with owner financing can be done much more quickly. This is because you can skip the requirements usually found with a traditional mortgage loan from a bank, such as verification of credit, income, and other financial documents.
- You have been unable to get approved for a bank loan: Owner financing has much more flexibility than banks regarding eligibility criteria. This can include things like credit score, income, and asset requirements. You can still purchase a property with owner financing if denied a bank loan.
- You don’t have sufficient funds for a down payment: Certain types of loans have minimum down payment requirements. Although this can vary on a case-by-case basis with owner financing, it can still allow you to purchase a property with a smaller down payment than you would otherwise need with traditional financing methods.
- You want to save money for other expenses: Owner financing can have fewer closing costs when compared to getting a loan from a bank. This is because you can avoid many of the costs associated with verifying eligibility for the loan, such as appraisals, flood certification fees, lender underwriting fees, and more.
- You can get a lower interest rate: It’s uncommon for owner financing to give you a lower rate than a traditional bank loan, but this is possible depending on your loan type. Head over to our guide on commercial real estate (CRE) loan rates to learn more about how rates are determined.
Buyer Pros & Cons to Owner Financing
| PROS | CONS |
|---|---|
| Closing costs can be less expensive than a bank loan | Interest rates tend to be higher |
| Easier qualification requirements | Typically requires shorter repayment terms of 10 years or less |
| Ability to close more quickly | Loans may have a final balloon payment |
| Can finance properties and borrowers that would not qualify for a traditional bank loan | Difficult to know what requirements the seller may have |
| Less common type of financing that can be difficult to find and negotiate | |
| Contracts can be complex and require the assistance of an attorney | |
When Should a Seller Consider Owner Financing
Offering owner financing as a seller can make it easier to sell your property. You might even be able to get better offers than if you were to require the buyer to obtain financing on their own through a bank:
- You want to get more offers for your property: By offering owner financing as a seller, you remove the requirement for a buyer to qualify for bank financing, which could help you get more buyers interested in submitting an offer to purchase your property.
- You need to finalize the property sale quickly: If you need to get funding more quickly, owner financing can accomplish this because it eliminates many of the requirements and verifications lenders review.
- You want to have a source of recurring income: With owner financing, you can receive recurring payments from your buyer faster. It can be a good alternative to investment property financing, a method that requires you to first acquire residential real estate for income purposes. You can learn more in our guide on investment property financing.
- You want to avoid making repairs to the property: Some lenders may not approve a buyer’s request for financing if the property they want to purchase is in poor condition. As a seller, offering owner financing can avoid these lender requirements and allow you to avoid coming out of pocket to pay for repairs.
Seller Pros & Cons to Owner Financing
| PROS | CONS |
|---|---|
| Negotiated interest rate can provide a higher rate of return than other investments | May require the assistance of an attorney to draft legal documents |
| Ability to finalize the property sale more quickly | Sellers carry the risk of a buyer defaulting on the loan |
| Property can be sold as-is | Existing mortgage may have a due-on-sale clause prohibiting certain types of owner financing |
Buyer Alternatives to Owner Financing
If you are a buyer and not convinced that the benefits outweigh the downsides, here are some additional types of financing you can consider. These financing options can offer better rates and the ability to work with a knowledgeable loan advisor to get you into a loan best suited for your goals.
Provider | Type of Financing | Maximum Loan Amount | Estimated Starting APR | Minimum Credit Score | Maximum Loan Term |
|---|---|---|---|---|---|
Multiple | $5 million | Varies | 560 | Varies | |
CRE | $12.375 million | 6.99% | 700 | 25 years | |
Hard money/fix and flip | $1.5 million | 9% and up | 660 | 24 months | |
Hard money/fix and flip | $2 million | 9.99% | 575* | 24 months |
* Minimum credit score of 680 is required for first-time property flippers.
Frequently Asked Questions (FAQs)
You’ll need to find a seller willing to pursue this option and negotiate the specific financing terms. We recommend that all parties hire an attorney to draft and review the legal documents to ensure everyone’s interests are protected.
As long as the seller of a property is willing to consider owner financing, there are no restrictions on property types. Owner financing can be used for both residential and commercial real estate as well as raw land.
Yes, owner financing can still be an option even if the property has an outstanding mortgage. However, some conditions may need to be met, depending on the existing loan’s terms. For example, some lenders require the loan to be paid in full upon any transfer of ownership.
Bottom Line
Owner financing can be beneficial for both buyers and sellers. It can allow buyers to purchase real estate if conventional financing is not an option. For sellers, it can expedite the sale of their property and serve as a source of investment income. However, this type of financing also carries risks. If you’re considering owner financing, we recommend hiring an attorney to assist with preparing and reviewing the paperwork and any other legal documents.
