What's better? Owner Financing VS Being a Landlord

General Landlording & Rental Properties
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What's better? Owner Financing VS Being a Landlord

Daniel Pessin
Member since 2019 · 7 posts · 5 votes

Hi everyone, I’m trying to understand the Pros and Cons on determining which is better, Owner Financing or being a Landlord.

From the research I’ve done, this is what I’ve found so far. I’m not 100% sure if this is accurate so any input would be appreciated.

Pros of owner financing:

1. The occupant will take better care of the property since they own it

2. Occupant pays for the property taxes and insurance

3. Occupant pays a higher interest rate at 7%

4. Because of the way seller financed mortgages are structured, you don’t incur capital gains tax until you start collecting on the principal of the loan, which, in a 30-year loan, allows you to defer capital gains tax for many years. This assumes, of course, that you fall into certain categories under the Dodd-Frank legislation.

Cons of owner financing:

1. You cannot refinance because you are not the owner. So if there is equity in the property, you do not get it.

2. Foreclosure is more difficult than eviction.

The Con I am most concerned with is not being able to refinance since you are not the owner assuming you transferred title during the owner financing. Is there a way to retain ownership and still get the other benefits?

Looking forward to hearing everyone’s thoughts and feedback.

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  • James Mc Ree
    Rental Property Investor · Malvern, PA · Member since 2016 · 1k+ posts · 934 votes
    6y

    Some key questions for you to consider are:

    1. 1. Do you want to own the property? (Sell or rent decision)
    2. 2. Do you want to be a lender? Keep in mind your buyer might not be interested in your mortgage offer.
    3. 3. Do you want to keep the property and be a landlord? It has responsibility and may have a profit or a loss.

    Some of your assumptions are optimistic.  Owners do not always take better care of properties than tenants.  You can influence property care as a landlord through inspections and a lease.  You are usually powerless as a lender.  You are also not guaranteed a higher than market interest rate.  That is negotiated.  Higher rates come with higher risk.  Why would a borrower want your 7% mortgage if she can get a 4% mortgage?  What are you getting if she agrees?

    Some additional considerations are:

    • You have much less responsibility as a lender than a landlord.  Your borrower may still call that they can't pay the mortgage, just like rent, but you don't have to worry about repairs, neighbor or municipality issues or anything else pertaining to home ownership.
    • Mortgages are highly regulated and lenders have tax obligations. Make sure you know what you are getting yourself into as penalties can be steep.
    • Your funds are obligated for the term of the mortgage.  You don't get fully paid for your property sale for 30 years with a 30 year loan, for example.  Your borrower might pay it off a year later.  You can sell the mortgage on the secondary market if you document it according to government guidelines when it is generated.  That will get your funds back sooner, but you lose your interest payments of course.  There is no guarantee you get all of your funds back if you sell the mortgage.  It is a market transaction.
      • You could end up managing an escrow account if you want to ensure your borrower pays their taxes and insurance.  This is just one more thing to do.  You don't want to lose the property securing your loan due to a tax lien.  Make sure you know what is legal as you run your mortgage business.
      • You have 2 exits for your mortgage: payoff and foreclosure.  Payoff is free, but may take a while.  You might not get any interest if the borrower stops paying until a foreclosure is complete and you will pay the foreclosure expenses.  You might then have a lot of repairs to do, or not.  You may get lucky and profit.  You can negotiate a loan modification to get the mortgage reperforming if you and your borrower want to avoid foreclosure.  All of this could be a headache, but evictions involve similar risks.

      Landlording allows you to retain ownership and responsibilities for the property while collecting rent.  The property can appreciate or depreciate.  Tenants can care well for the property or trash it.  You have to replace tenants from time to time which you don't have to do with a borrower.  There are many books written on landlording, so I'm not going to describe it here.

      Lending and landlording are two very different things.  You have to decide which you want to do, if either; or perhaps you just want to sell the property and get paid in full for it.

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