If you’ve been planning to buy a house, you may have noticed that it recently got a little more challenging. With inflation spooking politicians and economists alike, the Federal Reserve hiked interest rates 0.75% this month, and while that might not seem like much, it’s had a huge impact on the mortgage market. Interest rates on home mortgages have jumped to their highest levels in more than a decade.
And affording the loan is one thing. Qualifying for it is another. If your credit score is in shambles after three exciting pandemic years, you’re current on all your debt but have too much of it, or you don’t have enough cash in the bank, you’re going to have trouble qualifying for a mortgage. Simply put, buying your dream house just got a lot harder. Fortunately, even if you’ve had trouble qualifying for a mortgage or the current rates make you dizzy, you don’t have to commit to renting or living in your current home for the foreseeable future just yet. Owner financing might be a way forward without a mortgage—but only if the circumstances are right.
Land contracts FTW
Owner financing (sometimes called seller financing) is a simple concept at its core: You enter into what’s known as a “land contract” or a “contract for deed.” The owner of the house you want to buy agrees to let you pay them over time for the home. You give them your down payment, you both enter into a contract granting you an “equitable title” of the property (meaning you have a share of ownership), and you make monthly payments for a few years. Typically these arrangements are short-term: After five or, at most, ten years you’ll be required to make one last (huge) payment finalizing the sale.
The idea is that every month you gain a little more equity in the property, so after five years or so you can go back to the banks and get that mortgage, at which point you pay the balance owed and the house is yours. Often the seller will hold onto the title to the home until you make that final payment, so they (usually) technically remain the property owner while you’re living there.
Benefits of owner financing
The benefits of owner financing for a buyer are pretty clear:
- Speed. Because this is a contract between two private individuals, it won’t take months of fruitlessly faxing documents to different numbers to get the sale done.
- Lower closing costs. There are no bank fees or other costs associated with a mortgage-backed sale.
- Flexibility. The owner may not care how much you can put down and can be flexible about how much you’re expected to pay each month. In fact, every aspect of the deal is flexible, so it can be customized to meet the needs of both parties pretty easily.
For the seller, the benefits also include selling the home as-is. The buyer can always ask for an inspection or appraisal, of course, but the seller’s motivation to agree to those conditions may be low. The seller’s benefits also include the ability to sell the debt for a lump-sum cashout, and safety—if the buyer fails to make the payments, they get to keep the house and the down payment, and then sell the house again.
Risks to owner financing
Keep in mind that the owner of the property may still run a credit check—and may decide against selling to you for any reason. And that’s assuming they’re into the idea in the first place.
There are risks for the buyer, too:
- Higher rates. You often have to pay a higher interest rate on these deals. On the other hand, because these arrangements are short-term, you’ll probably pay less in interest overall.
- Possible foreclosure. If the seller is carrying a mortgage on the property, the bank may have the ability—and the desire—to foreclose if the property is sold. You shouldn’t attempt an owner financing arrangement unless the seller owns the property free and clear.
- That balloon payment. Most mortgages are 15- or 30-year terms, which means the payments are steady. The only adjustments that will be made will involve escrow costs for your property taxes and insurance payments—the actual mortgage payment is going to be the same month in and month out. But with seller financing, there’s almost always a balloon payment after just a few years, so you have to be prepared to cover that. If you’re counting on getting a mortgage 10 years from now and that falls through, you could wind up with nothing.
- Legalese. An owner financing arrangement is a legal contract, so always, always hire a lawyer when entering into one. No matter how straightforward it might seem, you need expert legal advice before signing.
For the seller, the main risk is that the buyer stops making payments and then refuses to leave the property—or leaves it damaged and in need of expensive repairs.
Finding owner financing
All of that being said, owner financing is not exactly a common arrangement. There are a few ways you can try to identify owner financing opportunities:
- Ask. If there’s a specific house you’re interested in buying, it’s always worth it to simply contact the seller and ask if they’d be open to exploring such an arrangement. Alternatively, if you’re renting a house or see houses for rent that fit your criteria, asking about an owner-financed purchase might find the landlord receptive.
- Real estate apps. Real estate apps and search engines like Trulia or Redfin usually let you add owner financing as a variable in your searches.
- Realtors. Local real estate professionals may know of property owners who are seeking or open to these sorts of sales. Making a few phone calls might do the trick.
- FSBOs. People listing their homes as “for sale by owner” might be more open to owner financing, because they’re already looking to duck Realtor fees and handle things on their own.
One final note: Because owner financing deals are contracts, just about every aspect of the sale can be negotiated. Don’t make any assumptions and do make certain your attorney knows your needs and wants when they review any agreement. Finally, be certain you understand every detail before you sign.
Owner financing isn’t a typical way to buy a home, but it’s one more option. If you’ve explored traditional mortgages and come up short, this might be your way forward.