J Bart Bradshaw CPA

Existing home sales are down in most regions of the United States, and the depressed housing market continues to slump even with improved job growth. Expiring tax credits are a factor in lower than expected sales, as are tighter lending requirements and fewer qualified buyers, a lingering effect of the financial crisis and economic recession.

For owners trying to sell their homes, the current environment might mean they have to lower their asking price, take a loss or continue to wait for the market to rebound.

However, for some sellers (and buyers) there is another option: owner financing. Popular when interest rates were very high in the 1980s, seller-financed homes have experienced a resurgence since 2008 in the aftermath of the financial crisis. Owner-financed home sales are up more than 50 percent in 2010 compared to 2008.

The Resurgence of Owner Financing

Until recently, owner financing was fairly uncommon – and less appealing – when compared to easy credit and low mortgage interest rates. Now, with many homeowners tired of waiting for a sale and a segment of buyers unable or reluctant to go through the traditional mortgage process, it is again emerging as an alternative to conventional mortgages.

In today’s market, lenders are requiring higher credit scores and larger down payments. Sellers are faced with lower home prices and longer wait times for qualified buyers, even with 30-year mortgage rates less than 5 percent. For many buyers, stung by unemployment, recent bankruptcies and foreclosures, owner financing might be their only route to owning a home.

Buyers with homes worth less than they owe might choose to walk away from their mortgages and start over with an owner-financed property.

Whether you are a motivated seller or a buyer with damaged credit or an upside-down mortgage, seller financing makes sense. But before taking a ride on the owner finance train, consider the advantages and risks that buyers and sellers might face.

Interest Income and Other Benefits

Although not for everyone, owner financing can offer some advantages:

• For a seller who needs to quickly free up cash, owner financing sometimes results in a quicker sale, thus alleviating financial stress.
• Owner financing can enable more buyers to enter the market, stimulating home sales nationwide and helping to stabilize prices.
• Sellers can often get market value for their homes instead of lowering the price to attract conventional buyers.
• Closings are faster.
• Fees associated with conventional mortgage loans are eliminated, freeing up more of the buyer’s money for a down payment, benefiting both the buyer and the seller.
• The seller enjoys a steady flow of interest income as well as possible tax benefits.
• Sellers get the benefit of having a liquid asset; the seller can convert the note to cash later, if desired, by selling it to a third party.

Potential Pitfalls

With all its advantages, there are some potential pitfalls involved with owner financing – for buyers and sellers alike.

In general, buyers can expect to pay more for an owner-financed home, in addition to a higher interest rate and a larger down payment.

Probably the biggest risk for buyers with an owner-financed home occurs when the seller still owes money on the property. Although this situation does not exclude owner financing, many mortgages contain a due on sale clause, and buyers could be at risk that the lender will call the note, or repossess the home, when ownership is transferred. There is also the risk that the seller could go bankrupt or the home could go into foreclosure if the seller fails to keep the payments current.

Other than the obvious disadvantages – the responsibilities and headaches associated with acting as a lender – sellers must be prepared to foreclose or evict if the buyer does not pay. Sellers also face the risk of damage to the home and being on the hook for the cost of repairs.

Structuring for Success

Owner financing can be set up in a variety of ways.

One popular way to structure a seller-financed deal is to do a land contract (sometimes called a contract for deed or installment sale agreement), in which the seller holds the title to the property until the buyer pays for the property in full. Seller and buyer can negotiate the down payment and interest rate.

Land contracts often include a balloon payment, at which time the balance of the note is due in full – typically after several years. At that time, the buyer can either hope to be in a position to obtain a conventional loan or have saved enough cash to pay off the loan. Some sellers will help buyers rebuild their credit and find financing to make the balloon payment when it comes due.

If the buyer is unable to pay, it might be possible to negotiate an extension. If not, the seller can take possession of the home. One advantage of the land contract for the seller (in some states) is the ability to take it back by forfeiture instead of foreclosure, as forfeitures are generally cheaper and simpler to do.

Other options for owner financing include private mortgages and lease/purchase arrangements.

Sellers and buyers should consult with a financial planning professional or attorney to set up the type of contract that works in their state and for their situation.

An Option With an Asterisk

Owner financing is a viable option in the current economy for motivated sellers who don’t mind trading immediate cash for monthly interest income and for buyers with damaged credit and sufficient cash for the down payment and monthly payments. As with any financial transaction, an owner-financed home sale might carry substantial risks for buyer and seller. Both parties should always do considerable due diligence and consult a professional prior to finalizing any deal.