Disadvantages of owner financing

If you’re searching for the perfect means of financing for purchasing a property, you have probably already met the term “owner financing.” It also goes by names like seller financing, owner will carry (OWC), or seller will carry (SWC). All those names mean the same thing: a financial agreement between the seller and the buyer. This is a loan like any other, but not exactly. Confusing? This article explains the meaning of owner financing and what to look out for before signing an agreement. We will take a good look at the potential disadvantages because that’s crucial for avoiding bad choices and eventually losing money. 

What’s owner financing?

First of all, let’s cover the basics. Owner financing is a financing agreement between the owner of the property and the buyer. It is an alternative to the traditional mortgage, without the bank’s participation, so the transactions are directly between the buyer and the seller. While there’s no bank involved, how owner financing works is similarly to any other bank loan. There’s mandatory paperwork to complete for the protection of both parties. 

The terms and conditions are flexible; the buyer and the seller decide upon them. But usually is involves a more substantial down payment at the beginning, followed by monthly loan repayments and interest rates after that. Usually, after 5-10 years, there’s a balloon payment, completing the purchase with the rest of the money owed, but terms can extend to as long as 30 years.

Why do people choose owner financing?

Owner financing is a different path you can take that comes with different freedoms and different limitations than a traditional mortgage loan. Although it has risks for both the buyer and the seller, owner financing can be the only option in some cases. 

For buyers, owner financing makes purchasing a home possible even if they don’t qualify for a regular loan. For sellers, owner financing makes it possible to sell real estate that doesn’t meet appraisal standards. 

There are special cases, like historic homes in not-so-good conditions. Owner financing allows the seller to sell a house that otherwise would not qualify. On the other side, the buyer gets to buy it, save a beautiful building, and live in a unique home.

It generally makes things faster, which can be both advantageous and disadvantageous. But some cases benefit from closing sooner and enjoy cutting down on inspection, appraisals, and bank fees. The standard minimum down payment is flexible: you don’t have to respect state or bank-imposed minimums. 

Also, there are no restrictions on the kind of property that can be sold or purchased through owner financing. It can be land, commercial real estate, or residential buildings and homes. 

It is obvious, that there are advantages to owner financing in some cases. But let’s cut to the hard truth: there are disadvantages, too. Depending on the situation, owner financing can be highly risky, with the big black cloud of foreclosure lurking above. To avoid ending up in an unfavorable situation, it’s important to know the potential disadvantages you can face. 

Disadvantages of owner financing

Let’s take a look at both sides.

Most frequent buyer’s disadvantages

Buyers commonly encounter the following disadvantages:

1. The costs are higher. If you take everything into consideration, the overall cost of the property purchased might end up being more expensive than that purchased with a traditional mortgage. If you want to use it as a second mortgage to complete your “master” mortgage, it’s advised to do an appraisal on the house to make sure it’s not overpriced. Interest rates are usually higher than with a regular mortgage, and all added up, you might pay much more than the initial selling price. 
2. The balloon. Most owner-financed mortgages include a significant balloon payment after a few years. Depending on the terms and conditions initially agreed upon, this can happen anywhere from 5 to 30 years. Regularly though, the 5-10 years interval is the most common. By that time, you need to secure financing by a second mortgage, or in any other way, to cover the balloon. In the worst-case scenario, you lose all the money you paid up until then and lose the property too.  
3. Due-on-sale clauses. If the owner already has a mortgage on the home when you arrive, the lender or the bank can demand full payment of the debt when the property is sold to you. The bank has the right to foreclose if there’s a due-on-sale clause and the lender isn’t paid. It’s advised to make sure that the seller owns the house, and, that the seller’s lender is okay with owner financing. 

Most frequent seller’s disadvantages

1. High risks. Despite all the advantages, it can be quite risky for the seller. If the buyer stops making the payments and defaults, the seller can face foreclosure. You should be prepared, and make security arrangements in advance, so you don’t end up in the long, complicated, and dreaded procedure of foreclosure. Doing a credit check on the buyer is an option. Although for example owner financing agreements usually don’t appear in credit histories.
2. If for any unforeseen reason, you end up back entitled to your property again, you might have to invest a lot of money in repairs. Someone might be entitled to using the property(or worse, not using it) for long years, so depending on how well the former inhabitant took care of the home, this could mean anything from minor changes to a whole renovation. 
3. The Dodd-Frank Wall Street Reform and Consumer Protection Act applied new rules to owner financing. Some homeowners must involve a mortgage loan originator in the process, and balloon payments may not be an option for everybody. This largely depends upon the number of properties the owner is financing through the course of the year. 

In conclusion

Owner financing is a great alternative to traditional financing possibilities, especially when opting for a regular mortgage loan is not a viable option for the buyer. In some cases, it comes with benefits, making it possible to secure financing on the terms of the parties involved. While owner financing doesn’t involve a bank, it still requires paperwork to protect both the buyer and the seller. On the downside, though, owner financing can come with disadvantages and serious financial risks that can end unfavorably for owner and purchaser alike. To avoid losing money and facing the foreclosure process, always do thorough research before signing an agreement. Considering your specific case there might be different perspectives to consider to make a good choice and get the best out of your real estate deal.

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