Owner financed real estate is still relatively popular. So who is it for? What are the advantages it provides? What traps are there to avoid?
Seller financing has been a common way to facilitate real estate transactions for several decades, and has been used in various forms for far longer. It comes in and out of fashion as other real estate and finance trends rotate, but while always potentially very attractive to both sides, it is often misunderstood or poorly used. So what do you need to know about owner financed real estate?
Seller Held Mortgages
This is perhaps the truest form of ‘seller financing,’ and is most similar to regular real estate transactions in which a home buyer pays cash or uses a traditional mortgage loan to purchase property. Everything else is the same, except the seller of the property also acts as the lender. A mortgage and promissory note is credit laying out the terms, and providing the old owner collateral in the property until the debt is satisfied.
A variation of this can be a second or third seller financed mortgage, which is taken out behind a new first mortgage obtained from a bank or mortgage company.
Land Contracts and Contracts for Deed
These are very common in Midwest housing markets. Instead of an upfront closing and transfer of title, the buyer contracts to buy the property over a period of time with mortgage like installment payments. Once the predetermined amount is paid off, the title is officially transferred to the buyer.
Rent to Own
Rent to own is similar to a land contract, except the new purchaser is clearly defined as only a tenant of the property until a later closing. Each monthly installment payment often sees part of the payment dedicated as rent for use of the property, with a partial credit towards purchasing the property and buying into equity. These agreements can vary in length, but two years is pretty standard. After this point, the renter-buyer will need to obtain outside financing or find the cash to complete the purchase based on a predetermined calculation of sales price. This may be current value, or a figure set in advance of entering the rent to own agreement.
Lease Options
Lease options are a variation of rent to own. It effectively means leasing with the option to buy at a later date. For example; 2 to 5 years from now. The difference here is that two separate legal agreements are typically used; the lease, and the purchase contract. The property is leased as with renting any other property, and the tenant secures the option to buy the property later. This is two separate transactions, and while the seller is obligated to sell if the buyer chooses to execute their option, and can, the buyer is not obliged to make the final purchase if they change their minds.
Subject-To
‘Subject-to’ deals are often used when the existing financing in place is attractive, or the balance is too high to facilitate a more traditional sale, or money can be saved by not paying off existing financing yet. The property is being purchased ‘subject-to’ existing debts and liens on the property. This is often done in conjunction with a ‘wrap-around’ mortgage, which is held by the seller and provides profit to the seller of the property.
How to Find Owner Financed Real Estate Deals
Owner financed real estate deals vary in availability by type of market, and by wider market conditions. Where buyers may be more scarce, or scarce for a particular property type, and when mortgage loans are hard to come by owner financing in more prevalent and more notably advertised. Even in a strong market, this can be seen in commercial property, rural property, large parcels of land, and even high end luxury homes, as well as being very common for mobile and manufactured homes. In the current market place, an even wider variety of regular homes for sale may be available with seller financing due to tight lending and low yields on other types of investments.
For sellers wondering where they will find renters and buyers that are interested in these types of transaction structures; they are pretty much everywhere. How fast a property will sell on terms like this really depends on the property, amount of down payment or upfront money required if any, the amount of payments, and the net price of the property in comparison to others, as well as how credible you appear. In other words; if you offer good deals in a credible manner they should go fast. When the opposite is true; they may still sit on the market for extended periods of time.
The Advantages of Seller Financing
There are many advantages to seller financing. Sellers can find this often helps them move properties faster and for more net proceeds, even in a tough market. It can also mean creating strong passive income streams and minimizing taxes on the proceeds of a transaction, while achieving higher yields than available elsewhere.
For buyers and real estate investors, this type of arrangement can be highly attractive in being able to avoid the hassles and high costs of borrowing from a bank of mortgage lender, as well as the opportunity to get better rates, and close faster. Often it won’t matter what credit looks like, and investors like the advantage of being able to control more property without tying up personal credit.
The Pitfall
The one main pitfall that both parties in these transactions need to watch out for is that balloon mortgages or rent to own agreements, which don’t fully pay off the sales price within the term of the contract, mean renter-buyers must be able to qualify for third party financing in that period of time. If they don’t; sellers can take back the property and all of the equity gained. To avoid this, buyers must formulate a real plan and timeline for building credit, applying for loans, and must carefully document all payments made.
