What are the types of owner financing?
Owner Financing Option #1: Free and Clear – Cash Sale or Mortgage
The simplest seller financing option is when an Owner sells a home free and clear of all liens. The Buyer makes a down payment and pays the negotiated monthly principal and interest payments to the Seller who then carries the loan balance in a private note.
Owner Financing Option #2: Lease with an Option to Buy (Rent to Own)
In this scenario, the potential homeowner retains the option to buy the home but without the actual obligation. The Borrower gains equitable interest in the home with a down payment while also making regular, monthly rent payments. At the end of the lease term, he/she has the option to pay off the remaining balance through a refinance.
On the other hand, the Buyer can also protect their options by recording the lease which will cloud the title, thus making it difficult for the Seller to sell it to someone else.
Owner Financing Option #3: Land Contract/Contract for Deed/Bond for Deed
Loans set up in this manner are similar to a mortgage, but rather than borrowing money from a lender or bank to buy real estate, the Buyer makes payments to the real estate Owner (or Seller) until the purchase price is paid in full.
Owner Financing Option #4: The Second Lien Position
This where a Seller carries a second mortgage lien behind the bank to either make a no or small money down deal. The Buyer will then make two payments each month – one to the senior bank lien Holder and a second to the private Seller.
Keep in mind that this option holds risks for the Seller. If the Buyer pays only the first lien Holder, the Seller must have enough equity or cash to foreclose and pay off the first, larger lien Holder.
Likewise, if the Buyer only pays the smaller second lien, the Seller still risks losing the property if the senior lien Holder forecloses.
Owner Financing Option #5: Wrap-around Mortgage
Offered by those reluctant to take a riskier, second lien Holder position, wrap-around mortgages are also an opportunity for sellers to earn a good rate of return.
For example, a Seller with a $100,000 mortgage loan at 4% and the property worth $150,000 would rather sell it to the Buyer with $10,000 down, carrying the entire difference [$140,000] at 7% on a wrap-around mortgage or all-inclusive trust deed. They would rather make 2% or 3% on the $100,000 rather than just 7% on the $40,000.
Yet, buyers should know the risks involved with wrap-around. In case you opt for a wrap-around mortgage, always go with an escrow company because you don’t know what the Seller is doing with your money. Escrow companies will ensure that payments make it to both the Seller and the senior bank lien Holder.
Another risk involves the bank discovering this particular lien. This type of arrangement violates what’s known as a due-on-sale clause that basically says the existing lender has to be paid off when the seller sells the property to a new Buyer. If the seller doesn’t do this and the lender finds out, the lender could declare the note in default and ask to be paid off in full.
However, in a healthy real estate market, the risk of this happening is rather small. Just think: Who would bother risking a performing loan for a non-performing loan if it’s paying as agreed? The only reason why banks might call a loan is if interest rates rise, as they may want to take another loan at a higher rate.
How do we figure out pricing for the home per month and details of the Bond for Deed contract (like the interest rate)? Are the terms completely up to the buyer and seller?
Only the Buyer and Seller need to agree to the terms of the Bond for Deed contract. You don’t need a real estate agent to draft the contract, as all the title work would be done by a title company. The Seller would determine the price and interest rate for any financed amount (the amount of money not paid as a down payment) they want to sell at and the Buyer would agree to the terms. This process is typically discussed between the parties before seeing the purchase agreement for the first time.
Check our amortization calculator to determine how much you can afford to pay per month and whether the terms they require fit your budget.
If we can come to an arrangement, is it just paperwork that we must fill out? And what are the fees to use your company?
Once you agree to the purchase (you can download a purchase agreement on our website), the title company would then move forward with the pre-closing work needed for the purchase. This process entails the research of the property to make sure that there are no liens on it (construction liens, parish/county liens, and so on), that the person selling the property actually owns it, and that there are no other outstanding issues in the public records related to the property.
Next, we would create all the legal documents that state that the Seller will convey the property to you once the terms of the purchase have been fulfilled. The Seller can determine how long they intend to carry the loan, which can be for a full thirty years or they can request a balloon payment after a specific time frame. Balloon payments just mean that there is an outstanding principal balance remaining on the loan when the loan ends that must be paid off or refinanced.
If you need to pay off the remaining balance in a lump sum at the end of your agreed loan term, this can be done with a balloon payment – refinancing with a traditional lender or paying the loan off in full. If you are not able to pay the balloon payment, you may request an extension or updated loan agreement from the lender, or try and sell the property paying the loan off with the sale.
Payments are typically amortized for 360 months (30-year note), but the Seller may want you to refinance through a traditional loan after a few years (five years is common).
As an example, imagine that the Buyer and Seller have a five-year loan term on a $100,000 sale price at 6% annual interest that is amortized over a 25-year term. In general terms, that would mean that the Buyer would still owe the Seller roughly $90,000 at the end of the fifth year. But because the property should have appreciated over the same period, the Buyer may be able to qualify for a traditional bank mortgage as the loan-to-value ratio of his new loan may be more attractive than the original Bond for Deed loan’s LTV was.
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What if we have a cash down payment, is that written in the contract as well?
Yes, the Buyer should specify in the contract the amount of money that they intend to use as their down payment, as well as the amount to be financed. The financing section of the contract should specify the annual interest rate for the financed balance, the term of the loan, the amortization period (if different than the loan term), and any other relevant clauses regarding the owner-financed balance of the purchase price.
Using a knowledgeable title company doesn’t only provide you with the security of a licensed escrow company but also brings an experienced and neutral third party to the table to verify that the contract terms work as intended.