Owner financing occurs in a real estate transaction when a seller finances a purchase directly with the party who is purchasing the property. This process eliminates costs associated with using a bank or other lending institution during the purchase process.
Arrangements for owner financing are common in transactions where a buyer cannot obtain regular financing. This type of arrangement can also occur if the purchaser has a private arrangement with the seller. Owner financing may be advantageous in many aspects but it may also create risks and responsibilities, especially for the owner providing the financing.
How Does Owner Financing Work?
Owner financing is a type of home sales transaction arrangement in which a buyer obtains their financing directly from the individual or institution that is selling them the property. Owner financing may be used if the buyer cannot obtain a traditional mortgage or home loan. Buying owner financed homes may be a viable option in situations where a buyer is unwilling or unable to pay the current market interest rates.
Owner financing may also be known by other names such as seller financing, creative financing or other terms. It is, in many cases, related to, but not necessarily always the same thing as a contract for deed.
What are Some Advantages and Disadvantages of Owner Financing Arrangements?
As noted above, one of the main advantages of owner financing is the lack of a need to include a bank or mortgage company in the transaction. By omitting these parties, the buyer saves costs and time normally associated with securing financing for a home purchase through a lending institution. Instead, the buyer deals directly with the seller and the two parties determine their financing arrangement together.
Additionally, in an owner financing arrangement, the finance terms are typically much more flexible and negotiable than those available from a bank /or mortgage company. Owner financing is often referred to as creative financing because the parties have the flexibility to create unconventional financing arrangements for their specific situation.
There are, however, risks and disadvantages for both the buyer and seller in owner financing situations. These may include:
- The seller may be required to take on additional risk of they buyer defaulting;
- The seller may require a more larger than normal down payment to help offset the risk of default;
- The buyer may be required to take on a higher interest rate than normal bank rates; and
- The buyer must obtain approval from the seller before they can close.
Both parties to the transaction should carefully weigh the risks and benefits of an owner financing arrangement. This consideration will assist in avoiding legal disputes and conflicts down the road.
What are Some Legal Issues to Consider with Owner Financing?
Owner financing is not a conventional method of real estate finance. Therefore, it is associated with certain specific legal issues and concerns. These include:
- A higher down payment;
- The transfer of the deed; and
- Negotiations.
In many cases of owner financing, a higher down payment is required for the buyer than that required in a traditional mortgage loan. Owner financing down payments may reach as high as 20%. A higher down payment helps protect the seller’s interests in the event a buyer defaults at a later date.
In most cases of owner financing, the deed to the home is not transferred until all payments are made on the home. This is an important consideration, especially if the buyer plans to transfer the deed in the future.
Since there are no institutional lenders involved, the parties must negotiate all financing terms on their own. This may lead to a more tailored finance arrangement but both parties need to ensure their interests are correctly represented and protected in the financing arrangement.
Owner financing arrangements are usually individually tailored to the needs of both the seller and the buyer. It is imperative that the house be appraised and inspected so that all aspects of the financing can be fair and equal. Owner financing contracts follow contract law, which outlines the terms by which a party may be able to get out of owner financing contracts.
What are Some Common Owner Financing Disputes and Conflicts?
While owner financing home sales contracts may be beneficial, they may also be the subject of various types of disputes, including:
- Breach of real estate contract;
- Disputes over down payments and/or interest rates;
- Default of repayments;
- Rejection of offer; and/or
- Disputes over appraisals.
A breach of real estate contract may involve issues including:
- Failing to transfer the deed at the proper time after the finalization of financing;
- Destruction of property; and/or
- Other issues related to the purchase.
Disputes can also arise over interest rates. Rates can sometimes be lower in cases of owner financings but they may also increase or balloon in the future. The buyer should be aware of the interest rate terms in the financing agreement.
A buyer may be facing a difficult financial situation, which is why they chose owner financing at the outset, instead of using a bank. A buyer may default on financing repayments in the future, if their financial situation declines.
A seller may reject the buyer’s offer, especially if another buyer comes along with better financing options, including qualifying for a traditional mortgage, which includes less risk for the seller. Local and/or state laws may vary regarding the seller’s right to reject a potential buyer’s offer.
Another issue that may arise is a dispute over an appraisal. A good financial arrangement relies on a proper and accurate valuation of the home being sold. If the appraisal is fraudulent and/or incorrect, it may lead to a legal dispute regarding the financing terms.
Laws regarding home sales and owner financing arrangements vary by state. Additionally, specific legal issues may vary depending on the specific contract between the buyer and the seller. Each financing arrangement will be different and vary based on the needs of the parties.
What if an Owner Financing Contract Is Breached?
It is possible the owner financing contract will be breached. One common way this occurs is when the purchaser fails to pay the regular payments and financing amounts. In many cases, payments are structured similarly to a mortgage, the only difference being the buyer repays the seller instead of paying a bank or mortgage lending company.
In an owner financing arrangement, a breach of contract may cause the buyer to forfeit their right to the property deed, which usually transfers once the payments are completed. This may cause the seller and original owner to lose profits on the sale because of the default. In these cases, a lawsuit may allow a seller to recover profits they lost on the transaction.
Another way an owner financing contract may be breached is when a seller raises interest rates and/or monthly payments in a way that violates the original contract terms. Prior to the closing process, the parties determine the terms of the monthly payment and finalize those terms into a contract. Unless specifically included in the contract, generally, the seller cannot increase payment amounts without the buyer’s consent.
How Can I Avoid an Owner Financing Dispute?
Owner financing disputes may be avoided through careful and open discussion during the negotiation process. Usually, both parties will need to be represented by attorneys in order to avoid conflicts in the negotiation.
Having attorneys present can assist the parties in reaching a suitable agreement for all involved. Additionally, full disclosure of financial backgrounds and appraisal methods may help prevent fraud and/or misrepresentation.
Should I Hire a Lawyer for Help with an Owner Financing Dispute?
Yes, if you are involved in an owner financing dispute, it is important to seek the assistance of an experienced mortgage lawyer. These types of disputes often involve highly technical real estate laws.
A lawyer can review the case, any contracts involved, and advise you of your rights and options. They can also help file a lawsuit if needed and represent you during any court proceedings.
