How Does Seller/Owner Financing Work in Real Estate?

April 26, 2023
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Seller financing (also known as owner financing) can be an effective solution for both sellers and buyers in today’s market.

Seller/Owner Financing: An Old Solution for a New Problem

Seller financing (also known as owner financing) can be an effective solution for both sellers and buyers in today’s market. As interest rates continue to climb, this trend is helping some real estate buyers spend less and gain access to capital that banks and other traditional mortgage lenders are not providing. Additionally, the seller tends to benefit by seeing more money from the same transaction.

Unlike most other trends in our society today, this one is not driven by the latest high-tech solution or new idea. It is developed around an age-old, time-tested method of financing that offers simplicity, transparency, security and a more personal way of doing business. These are critical benefits real estate sellers and buyers are looking for today, and often ones traditional mortgage providers are not offering.

Seller financing was the way it was done before banks existed. The method’s popularity increases in times of uncertainty, especially when there are higher interest rates. Owner financing was used extensively during the 1980s when interest rates rose to more than 18%! But anytime interest rates and loan costs rise, a precarious economy can make it almost impossible to get a decent return from a low-risk investment. This is when buyers and sellers can effectively leverage owner financing.

A Closer Look at the Benefits of Seller Financing & When to Consider It

Seller financing can be very beneficial. It cuts away the clutter, goes back to basics and enables the sale and purchase of a property with a protected return. For sellers, it’s an investment secured by real estate they have personally owned and know well. For buyers, it’s a loan from an individual or group of people who have a personal connection with the property being loaned. This eliminates expensive fact finding and documentation and passes that savings on to them as the borrower. This can be a real win-win for both buyers and sellers. But when – or in which situations – should one consider the option of owner financing?

For certain property types and situations, seller financing is particularly attractive. Non-owner-occupied properties such as land, vacation homes, businesses, and commercial properties are prime candidates. Interest rates on these types of properties are generally higher and few qualify for government-insured loans that offer more attractive rates.

Seller financing is also a great solution for homes that are paid off, including ones in which the owner has a lot of equity and can pay off to allow seller financing. This is common when sellers are selling their property to fund retirement and is often used in lieu of a reverse mortgage. While it doesn’t offer the benefit of a reverse mortgage to sellers who want to continue living in the home, the financial benefits for the seller are usually far more favorable.

Owner Financing in Real Estate: A Smart Investment, Simpler Process for Sellers & Buyers

Sellers who have high equity tend to look for a safe place to invest money from the sale. Many of these individuals or groups may be even reluctant to sell because they don’t want to take their money out of real estate and put it into a higher risk investment. A mortgage on real estate they have already owned can offer that security. What other investment can you make that allows you to have more knowledge about the product in which you are investing than anyone else? Sellers are often not be able to get as high of a return on their owner-financed loan from a traditional investment at the same level of security or risk. A better return for the seller on an asset they know very well is a nice solution. Even with this and because of the other savings, the seller can offer a lower rate to the buyer. This makes the property more affordable and gives it an advantage when competing with other properties on the market.

Buyers on the other hand, may prefer seller financing for its simplicity and its cost savings. Closing costs are typically reduced dramatically, so more of the buyer’s up-front money goes to principal. Interest rates are usually fixed and repayment terms are simple. This eliminates many unknowns and provides a straightforward solution that’s easier to understand. The cost savings for buyers may also enable them to secure a loan on a property traditional mortgage providers could not offer.

To illustrate the simplicity, an experienced closing agent offered the following: A seller-financed sale typically requires three documents totaling 9-10 pages, whereas a loan through a local lender might have 20-30 pages. A loan package for an out-of-town lender may include up to 180 pages! It’s also a lot easier to communicate with the seller than with a large corporate lender. Plus, a personal relationship can be created with the seller that will surely help close a seller-financed sale faster.

Seller Financing a Property Can Result in a True ‘Win-Win’ if the Option Fits

Interestingly and because of these efficiencies, seller financing can mean significant savings for the buyer and more money for the seller. Consider this example: A buyer borrows $250,000 from a traditional lender at 8% interest. Lender closing costs are conservatively $5,000 more than a seller-financed loan. Payments on the loan are $2,091.10 monthly for 20 years. Seller financing for the same loan would look like this: The buyer pays the $5,000 saved on closing costs as an additional down payment and finances $245,000 at 7% for 20 years with monthly payments of $1,899.43. The buyer saves more than $46,000 in interest over the life of the loan and the seller gets a long-term low risk investment at 7%. Truly a “win-win” situation.

Certainly, owner financing does not work for every situation. Whether you are buying or selling, to ensure that seller financing is a good option for you, first consider your objective. As a seller, if your property is debt free or if you have a lot of equity and want to convert that in to a secure investment, there is a good chance owner financing is the best route. However, if you have little equity or if you have other debt you need to pay off or you don’t want to tie up your money for a long time, then seller financing probably is not the right choice for you.

For the buyer, it would seem that saving money, a more personal relationship with the lender (seller), and realizing a smoother and lower-stress closing would make seller financing desirable. That’s not always the case. The seller may need a larger down payment than you can handle, you may need longer terms than the seller can provide, or you may want a property that the seller is not in a position to finance. So, you must consider your objectives and be able to reach a mutually acceptable agreement within your timeframe and the available financial resources.

Owner financing can help a property get sold and purchased in ways many traditional mortgage providers cannot achieve. This kind of financing can provide a workable, simple and in many cases better alternative for both the seller and the buyer — as long as all the correct steps are taken. In the end, if you decide to explore seller/owner financing options, always consult an attorney and an accountant to make sure you have the information and advice you need for something as important as a real estate transaction.