Owner Financing - Why?

Question

If I own a home, why would I agree to finance the buyer and have the buyer pay me monthly payments instead of having the buyer go to the bank. How would I, as the seller,  protect myself against the buyer defaulting on the payments? I still don't really understand this concept. Wouldn't this be riskier for the home seller?

Michael Boyer · Answer

I owner financed one condo, and I recommend it if you have a paid off property (stickier otherwise), a strong buyer candidate, and it works for you and your situation.

There are a few advantages mentioned already (tax, earning higher interest than alternatives investments, etc).

Often,  you can get more money monthly with owner financing than you did while managing the place (with no maintenance, management or capital costs)! A huge benefit--another exit strategy for the landlord to keep getting checks with no lawns to mow or walls to paint.

You can, as mentioned, attract a larger pool of buyers (investors, folks with max loans, solid buyers less able to access conventional ).

You can ask a higher price (no appraisal needed if you are the bank!), design your terms, and work out what you will be paid with interest..

Sometimes, it also makes sense if there is not available financing due to the quality of the asset (think run down property) or simply does not qualify for most program (broken condo) or even where terms are tougher (like 5+ units/ commercial).

Risk? Well, this is going to depend on the quality of your buyer, of course. But I can say for me it is my easiest, most certain check every month (literally passive on autopilot). With  a decent down payment (I went with 10%), you have a first mortgage/deed of trust and note so you are relatively secure (curious, look at your states foreclosure rules, be it judicial or nonjudicial). As banks and Wall Street have long since discovered-- owner occupied first mortgages with a decent down, and screened, credit worthy buyers are fairly low risk..

Tips: use a title company, traditional documents (with your designed note terms), and screen your buyers (it was admittedly easy for me as they had been pre-qualified by a bank but liked my low fee, low transx costs financing better). You will actually get a mailbox full of letters from people wanting to buy your note and mortgage after it records btw (if that is your plan be sure and find out what they want in terms of forms, buyer data, etc).

Finally, I think you get one owner finance per year (See Dodd Frank exceptions). NOTE: I did my first owner finance pre- Dodd Frank, and just listed a second condo last month with the owner finance option but a cash buyer emerged quickly.

Best of luck

Jorge J. · Answer

Instead of the buyer paying the bank the interest on a home loan, the buyer instead would pay the seller the interest. So in effect, the seller would, at the end, get the total principal ( asking price of the house), plus additional cash from the interest? If so, this makes much more sense since the end result is more cash, yes?

So if the buyer misses payments, and I as the seller take him/her to court, and I win the case, how am I assured that I will still get my money? What if the buyer still can't pay after the court case is done? This is still not completely clear to me.

In terms of taxes,  my understanding is that the profit I made by selling the house would be taxed at 20% ( Long-term capital gains ), and if I provide seller financing instead, I would get taxed on the monthly amount by the ordinary income tax rate ( Exact amount would depend on my tax bracket).

Thomas S. · Answer

You provide owner financing for multiple reasons when as the seller you do not require the cash. It creates a monthly income and is usually at a higher interest rate that you could get by investing. A second reason would be to make a sale happen when the buyer does not have sufficient cash and financing. On a investment property it defers capitol gains.

How you do it is by having your lawyer draw up a legal mortgage contract (paid by the buyer) and when they default you take them to court.

Jorge J. · Answer

What are the options when the seller starts to default on payments?

David Dachtera · Answer

@Jorge J.

It depends on the reason you need to sell. If your motivation is greater than the buyer's ability to get bank financing, seller financing can be a possible answer.

For protection you do like any lender does and file a lien against the property securing your position. The buyer then gives you a mortgage which also gets recorded tying the note to the lien, just like the bank gets. You ARE the bank!

Once you've had some months of consistent payments you can sell your note on the secondary market (assuming it meets market criteria) and get a lump sum. Won't be face-value or balance remaining, but "a bird in the hand ..." ("time value of money").

Hope this helps...

David J Dachtera

Owner Financing - Why?

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