Traditional Financing Vs Owner Financing

By Craig Donofrio

Posted on September 16th, 2022

image of woman choosing loan types

Owner financing — also known as seller financing — is a somewhat rare but viable way for buyers to find non-traditional financing for a home purchase.

With owner financing, there is no lender involved. Instead, the seller of the home becomes the lender. The buyer makes a set amount of loan payments to the seller every month, and the terms of the deal are set by the seller.

Typically, most owner financing deals last about five years, not 15 or 30. At the end of the five-year period, a balloon payment is due. It's up to the buyer to refinance the loan into a mortgage and use the proceeds to pay the seller what they are owed.

Traditional Financing Vs Owner Financing: At a Glance

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Traditional Financing

Traditional financing means getting a loan through a lending institution, like a bank, credit union or mortgage company. These loans can be conventional, non-conforming, or government-backed.

At closing, the buyer hands the seller a check for the home, and if applicable, has their bank send money to their bank to cover any outstanding mortgage balance you carry.

Mortgage options such as VA (Department of Veteran’s Affairs) and FHA (Federal Housing Authority) are a type of traditional financing.

Though these loans are backed by the government, they are funded through a traditional bank. This option can be beneficial to buyers because these types of loans typically have lower down payment requirements than conventional mortgages and are generally easier for people with less than perfect credit to obtain.

One major difference with government-backed loans is that lenders require additional assurance that the asset being backed is in good repair. For example, when a buyer takes out a VA or FHA loan, a home must meet “minimum property standards” as defined by the government agency backing the loan in order to be eligible for financing.

With owner financing, no such requirements exist.

Owner Financing

With this type of financing, the homeowner acts as the lender and the home buyer pays for the home in installments.

Owner-backed financing can take a number of forms and both the buyer and seller should hire an attorney to review the papers and provide assistance.

It's unusual for a seller financer to carry the loan for 15 or 30 years like a traditional mortgage, although it's not out of the question. Typically, though, sellers don't want to be a bank forever.

In most cases, the buyer pays the owner-financer monthly for five years, and after that period, a balloon payment is due on the loan. At that point, the buyer must take out a mortgage from a bank and pay the seller the remainder of the amount due.

Is Owner Financing a Good Idea?

Owner financing benefits the seller because the owner will usually make more on the entire deal than selling it outright because of the interest collected and lack of closing costs.

However, it's a lot of risk. If a buyer defaults on the loan, the property reverts to the original owner, but the buyer may have made expensive damages that they are now on the hook for.

For buyers, owner financing typically carries a higher interest rate, and owners usually expect a sizable down payment. Every deal is different, though, so buyers should have a real estate lawyer with them to review contracts.

Buyers should also be aware that if they can't find financing at the end of the owner-financed loan, they can lose their home and all the money they already paid.

Additionally, owner-financing is typically only available to owners who own their property outright.

For buyers who don't qualify for traditional financing, owner financing can be a good path into homeownership. However, you'll want to negotiate favorable terms. Owner-financed deals can be lopsided in the seller's favor, which is why we recommend having a good buyer's agent by your side.

To find a great agent, we recommend our friends at Clever Real Estate. Clever can match you with top, local agents who can help you negotiate a fair home purchase. Clever's agent-matching service is 100% free to use, and for home sales over $150,000 in 41 states, you can get up 0.5% cash back after closing!

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Posted in Buying a House, Mortgage, Selling a House