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Explaining how owner financing works

June 24, 2011
By MARIO D'ARTAGNAN, Real Estate in Perspective

One alternative to bank financing is when the owner of real property owns the property free and clear and wants to receive monthly income as opposed to cashing out when the property sells. From a buyer's perspective, he or she may not be able to show enough income or cannot substantiate enough time of employment to satisfy an institutional lender's guidelines for lending. In many cases, owner financing may be just the solution.

The way owner financing works is that the buyer and seller agree to a purchase price and terms of the owner financing, or what is commonly called a Purchase Money Mortgage. Typically, the seller will require that the mortgage interest rate be somewhat higher than what the institutional lenders are charging. Moreover, the seller generally will not charge fees that a lender charges. For example, banks will most likely charge points based on the amount of the loan. Each point represents 1 percent of the loan amount. Let's say a bank is loaning $100,000 and charges 3 points, or 3 percent of the loan amount. That means the borrower has to pay an additional $3,000 to acquire the loan. With seller financing, these points are waived, so the borrower automatically saves the expense of funding the loan.

Once a contract to purchase is executed by the parties, the seller would have a mortgage and promissory note prepared that provides all of the terms of the mortgage agreement. The seller would execute a warranty deed at closing and would be recorded on behalf of the buyer. In the event that the buyer/borrower defaults during the term of the loan, the seller would file for foreclosure in the same manner a bank does.

Although many lenders issue loans over a 15, 20 or 30-year period, owners sometimes make the loans for a period of 3 or 5 years, wherein the balance of the loan is due and payable at the end of this period. This is called a "balloon loan." In other words, the mortgage balloons at the end of the period prescribed in the mortgage instrument. This time frame allows the buyer/borrower to accrue time on the job, improve his or her credit rating and eventually qualify for conventional financing. However, some sellers of property will forego the balloon requirements and prefer to have the monthly income for many years.

Owner financing in many cases permits the seller to ask for a purchase price somewhat higher than the prevailing market prices. Basically, it solves a problem for the buyer that cannot obtain conventional financing, and there are no fees associated with the owner financing. Buyers typically do not mind paying a little more for the property because the seller is doing them a favor. As property appreciates, the extra that is paid up front should be offset by the time the buyer re-finances.

So, if you own property and are looking for a means to create monthly income, a purchase money mortgage may be a good alternative.

Mario D'Artagnan is a broker associate with Realty World Florida Inc. He is a former investigator for the Florida Real Estate Commission. He is also a former real estate instructor. He is a published author and has been a keynote speaker on the subject of agency law. He is also a veteran of the U.S. Air Force. For questions or comments contact D'Artagnan at or call 239-565-4445.



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