The answer to the question: How does owner financing work is not a simple one. It really depends on who you ask and what they are trying to sell you. I only want to provide you with the best information so you can decide which type of owner financing is acceptable for your home purchase. Many home sellers are flexible and may offer different agreements depending on how much of a down payment you have or sometimes if you prove to be a good payer over time they will convert a rental agreement to a finance agreement.
First we’ll review the different documents used to complete an owner financed real estate transaction.
Promissory Note and Mortgage
What many would refer to as “true owner financing” is a lot like a bank loan, you enter into a purchase and sale agreement or sales contract. Then there is a closing at a title company or closing attorney’s office. At the closing you sign a promissory note and a mortgage. The seller signs a warranty deed or trust deed over to the buyer. The recorded mortgage creates a lien on the property.
You should ask to get an amortization schedule which is a list of your scheduled payments and breaks out the principal and interest to be paid over the life of the loan. These documents will also specify if there is a balloon payment due and when. Prepayment penalties can be an unwanted surprise depending on the terms your are getting and if you will be paying off early or refinancing.
It’s best to get a copy of the documents in advance and read them carefully or have your own attorney review them on your behalf. The most important thing is that you know what you are agreeing to and can meet all of the terms.
Balloon payments are typically the toughest since you’ll have to come up with a large lump sum payment when the balloon is due. Either in cash or you need to get a new loan from a bank or private lender.
If you agree to a balloon payment it may be best to set aside in savings enough to pay the balloon off in cash when it’s due. Or make extra principal payments, just make sure to keep good records of all payments made, copies of cancelled checks are best. Notations on your amortization schedule are also a good idea each time you make a payment.
In most cases the note is kept private and the original is held by the seller. The seller (lender) may assign or sell the note to another party or bank after the closing or at anytime in the future.
Advanced Tip: If the seller ever wants to sell the note offer to buy it at a discount to save money. Many sellers decide they want a lump sum of cash and will take less than the full balance owed in exchange for an early payoff. Note brokers and banks are always soliciting private mortgage holders to sell their notes at a discount starting when the mortgage is recorded in public records.
Agreement For Deed or Land Contract
Much like a note and mortgage except the deed does not get transferred to the buyer until the last payment or payoff is made. Depending or where you live or where you are buying a seller financed home, this type of agreement may be more common than a note and mortgage. The land contract can be recorded which has about the same effect as the closing documents described above. If yours is not then it is referred to as an un-recorded land contract. This leaves the property in the sellers name and he could take out other loans or have personal judgments against him attach to the property.
This is where you are leasing the property and have a set option to buy price at some time in the future. Typically there will be a lease agreement and an option contract. The option contract can be recorded creating a contract interest (similar to ownership interest) for you in the home. It has been my experience the county tax collector will not accept an option agreement as ownership to file for a homestead exemption where I live in Florida.
Contract For Option
Similar to a lease option except you get an agreement that says you can get an option only when you have met certain terms and are ready to close in the future. This agreement is meant specifically NOT to transfer or create any ownership or contract interest to the buyer. This means if you are in default of the lease you can be evicted like a regular tenant.
Rent to own is not Owner Financing
The term Rent to own is used in advertising to let the prospective tenant buyer know they can buy the house with rental payments and some other agreement in the future. In many cases the tenants never actually buy these houses. The purchase price or time frame to buy may not be fixed and in many cases if market values go up so can your price. Often times this term is used to get a premium monthly payment for the landlord or make the property more attractive to perspective tenants. The phrase could and is often used interchangeably with lease option or lease to own. What you actually get really depends on the paperwork you sign. These types of agreements are usually not recorded in public records, therefore it is best not to put up a down payment or large non refundable deposit when entering into this type of agreement.
In summary to answer the questions; What is owner financing? How does is work? What is seller financing? …… is when a property owner sells a house on terms or payments agreeing to accept installments over a period of time in exchange for ownership interest in the real estate. Partial owner financing or owner assisted financing could mean the seller is willing to finance a 2nd position if the buyer can find a bank or private lender to finance most of the purchase amount in first position.