For property owners who want to ultimately realize more profit from a real estate deal or who are looking for regular payments, owner financing is the way to go.
For buyers who might not qualify for a traditional mortgage or who are looking for more flexible financing, owner financing can be a magic bullet.
And if you’re willing to get really creative, using a wrap-around mortgage and a private lender can generate passive income and set up a win-win-win situation for everyone involved.
But let’s start at the beginning and define owner financing.
What Is Owner Financing?
When a buyer and a seller work out an agreement where the buyer pays the seller directly for the property over time, they have worked out an owner-financed deal. These deals do not involve banks, so they don’t require the same inspections and approvals; the terms are very flexible.
As a real estate investor, you might find yourself in a situation where you want to buy a property with owner financing, or you might choose to sell a property this way.
Let’s look at the pros and cons to both the buyer and seller, plus some unique strategies you can use to set up these deals.
A Win for the Seller
Sellers consider owner financing for a variety of reasons:
- Sell a problem property
- More potential buyers
- No fees
- Monthly income
- Flexible terms
- Receive full property value
Or maybe it’s hard to find an agent who will list the property because it’s just not worth that much and won’t bring in much commission, so a traditional sale isn’t a great option.
Since buyers don’t need to jump through the same hoops as they would to qualify for a traditional loan, your pool of buyers for the property is much bigger. If you’re willing to negotiate a deal with no down payment, that attracts buyers as well.
Since owner financing doesn’t involve a real estate agent, there are also no fees. And there’s no cost for an inspection. In other words, no closing costs, and more money in the seller’s pocket.
The seller also starts taking in a steady monthly income. For sellers who don’t need the cash up front, this is a huge benefit.
And because the terms are flexible, sellers can negotiate the sale price and interest rate that works for them. And the seller and buyer could renegotiate as needed down the road.
Sellers can negotiate terms that get them the full property value if they use owner financing. It will take longer to realize the full value, but sellers can receive what the property is worth if they’re able to collect monthly payments rather than a lump sum.
A Win for the Buyer
As a buyer, why work with a seller instead of a bank?
- Qualify quickly
- Flexible financing
- Quick closing
- Avoid “extra” costs
For both sellers and buyers, the financing is much more flexible. You can negotiate the terms that work for you, including the amount of monthly payments, interest rates and down payments. Keep these 4 costs in mind as you develop your offer:
- Insurance (PITI)
- highest offer: no down payment, highest monthly payments, 0% interest
- middle of the road offer: small down payment ($1,500), slightly smaller monthly payments, 0% interest
- lowest offer: large down payment with small monthly payments, or purchase the property for cash
These deals typically have a 5- to 15-year term, but you can negotiate whatever terms work best for you.
You can also come up with more creative terms that work for both parties, such as interest-only payments for the first year or a 5-year term with a balloon payment at the end. When making offers, keep the term options straightforward, but don’t be afraid to think creatively.
And don’t be afraid to ask for 0% interest. Just ask for terms where you pay the seller “until paid.” In other words, your payments go toward the principal, not the interest. If they’re not interested, just negotiate a number that works for you.
These deals are also flexible in terms of closing; they can close much more quickly.
Buyers can also avoid extra costs in some situations, such as escrow taxes and insurance, depending on any existing mortgage and the terms of your deal.
What Do I Do with a Seller Financed Property?
Rent-to-own is a great option for a seller-financed property. You can collect a down payment and use the rent to make your own payments, with a difference that makes the deal a good one for you.
You might also want to add the property to your rental portfolio.
Owner financing does involve a few risks. Before diving in, make sure you understand the potential downsides so you can avoid an ugly situation.
- Buyer default
- Missed payments
Keep the transaction professional by hiring a third party to collect payments. Make sure you have a plan in place if the buyer isn’t holding up his end of the deal; you don’t want to get stuck with months of overdue payments and no resolution in sight.
Strategy for Owner Financing
If you’re looking to buy a property using owner financing, target absentee or out-of-state landlords with 50%–100% equity in their properties. They’re used to collecting rent checks and might not be interested in receiving a lump cash payment for the property.
You can also look for both single-family and multi-family properties or apartment buildings. With these criteria, you can easily get a list of property owners to contact and start sending out direct mailings.
If your marketing explains the benefits of owner financing, you’ll start getting calls from sellers ready to discuss the details and set up a deal.
Wrap Arounds and Owner Financing
If the owner has a mortgage the seller can’t pay off, one option that makes the sale a great deal for the seller is to wrap the buyer payments around the existing mortgage.
For example, if Shorty Seller was asking $125,000 for a property that he owed $70,000 for, Ivan Investor could set up a wrap-around mortgage. Ivan would make the payments each month for the current $70,000 mortgage. And when the deal balloons in 5 years, Ivan would pay Shorty the $55,000 difference between that mortgage and the $125,000 Shorty was asking for the property.
Now, Ivan doesn’t actually take on the $70,000 loan in this deal. He’s just making the payments. Shorty gives Ivan a contract for deed, which gives Ivan control of the property. Ivan gets the tax benefits. But as far as the bank is concerned, Shorty is still responsible for the loan. And Shorty keeps the deed for the property; Ivan has just got the contract.
All this changes once Ivan makes the last payment. At that point, the property belongs to Ivan Investor.
Word of Caution: Mortgages sometimes have terms that require the balance to be paid if the property is sold. If you’re considering a wrap-around mortgage situation, get some legal advice.
Consider the possibilities available if you approached owner financing with a private lender. If you purchased a property with funds from a private lender, then sold the property using owner financing, with the right terms everyone would win.
The private lender would earn interest on their investment. You would earn a monthly profit based on the difference between what the buyer is paying you and what you owe your private lender. And the buyer gets all the benefits of an owner-financed deal (easy to qualify, lower down payments, lower closing costs, quick close).
Again, a final word of caution…
Many states regulate deals of this sort and deals that are made based on borrowed money. And your private lender needs to agree to wrapping the mortgage when you sell the property using owner financing.
Always, always, always consult a legal advisor before doing deals like this.
What creative deal financing strategies have worked well for you? Let me know below.