Owner carried financing can be great for both buyers and sellers. Here’s why.
What is owner carried financing? Great question. I’ll explain.
Money to buy a house can come from lots of different places. Some home buyers have cash, often from the sale of another home. Most buyers need to borrow a sizable portion of the purchase price of a new home from somewhere. Usually, that’s a bank or mortgage finance company. But in some cases, the money to buy a home can come from the seller.
You may be wondering how a seller can loan money to a buyer at all. Why would you loan money to someone just for them to turn around and give it back to you to buy something you’re selling?
The reason this is possible is that the loaned money is not actually changing hands from the seller to the buyer, and back. It is being created, essentially, by the creation of a new loan from the seller to the buyer. This is actually how banks lend money as well, and it is how the “money supply” in the economy at large grows. Without making your head explode with a lesson on fractional reserve banking (you can watch this video for a great summary of that), I’ll stop there and answer the original question—how is this good for both buyer and seller?
First, let’s start with a buyer problem. If there is some reason the bank can’t or won’t lend to a particular borrower—perhaps less than ideal credit or income—the buyer may not be able to buy a home at all. Or, if he is able to buy a home, it may be at a higher interest rate, or with the addition of PMI (Private Mortgage Insurance). Those can add considerable cost to the house, reducing the “amount” of house that can be purchased.
Now, let’s look at a seller problem. Let’s say there is some reason a traditional lending source won’t lend on the property. As in, never. These situations do happen, like when there is a remodel that the bank doesn’t like that would make the home more difficult to sell in the event the bank needed to foreclose to get their investment back out. It may be a remodel that a buyer would still want, and completely safe—but unconventional enough that a conventional loan won’t work.
Owner carried financing solves both of these problems. In cases where the owner has enough equity that she can afford to take less in cash and more deferred through loan payments from the buyer, it can be a beautiful thing. In the case of a property that is tough to finance, offering to carry all or part of the buyer’s loan opens up the property to more potential buyers. This is good for the seller.
In the case of the buyer who is having trouble getting approved for a conventional mortgage, the ability to take out a loan with the seller opens up more possibilities as well. The great thing about it is that the terms are fully negotiable between buyer and seller. If the owner is willing to accept 20% down but carry the rest, and the buyer can meet those terms, a possible deal can be struck. If the owner only needs 5% in cash and will carry the rest, that can work as well.
What about a deferred payment plan? It’s possible. What about creative arrangements for interest rates based on future events? Or maybe a lower payment for a few years followed by a balloon payment that could be refinanced conventionally at that point? All of these are possible, subject only to the agreement of buyer and seller (and some legal requirements for a valid contract, which would all be taken care of by the real estate agents and a knowledgeable escrow company).
The point is that owner carried financing opens up possibilities that many buyers and sellers haven’t thought of before. The seller could get some investment income out of the deal, and the buyer may be able to afford a house that he otherwise wouldn’t be able to buy. It’s a win/win.
These benefits don’t mean it’s right for everyone in every deal. There are definitely times when owner carried financing doesn’t make the most sense for either the buyer or the seller. Interest rates expected by a seller carrying the financing are typically going to be higher than a traditional mortgage, for instance. And not every seller can afford to defer the payment of their equity. Many need to be cashed out so they can buy their next home.
Nevertheless, owner carried financing can be a creative and useful way to solve legitimate problems for both buyer and seller. Even if a home isn’t listed with owner carry as an option, it never hurts to ask. Of course, it also never hurts to have be working with a Realtor who knows how owner carry works and can help negotiate it for you.
Note: I actually purchased a home using this technique many years ago. So I know a bit about it, and can help you if you are either a buyer or a seller interested in owner carried financing.