Did you know that I start every single conversation with a seller with the exact same question? Probably not. I mean, how would you know?
Well, I do, and it is one of my favorite parts about real estate investing. The question I ask every seller is: “Will you do owner financing?”
Owner financing is the crown jewel of real estate (in my opinion). It affords you the ability to get into a deal a heck of a lot easier and much faster.
What Is Owner Financing?
Put simply, owner financing is when the owner of a property sells it to a buyer but acts as the lender and holds a “note” against it. Instead of paying a normal bank every month, the buyer pays the original seller every month. Going into the agreement, the seller and buyer have an agreed upon payment amount and term length, just like a buyer would with a regular bank.
Owner financing terms are normally much shorter than your standard 15- or 30-year bank mortgage. Before the agreed upon term expires, the buyer must pay off the seller with a lump sum payment, which is typically obtained through a refinance with a regular bank.
The Benefits of Owner Financing
Well, what is probably the worst thing about real estate investing? I would say it is the process of acquiring a mortgage from a regular bank lender. They want your left leg and your first-born child. Or, put dryly, they want 90 days of bank statements for all your accounts, your last two years of tax returns, a personal financial statement, and your credit score. Throughout the process of gathering all of this, they’ll send 43 emails, leave 31 voicemails, and ask you to sign 27 or so different forms.
With owner financing, you effectively avoid almost all of this. Mr. or Mrs. Seller, more than likely, will not run your credit and pour over your personal and financial affairs. In my experience, the most a seller is looking for is that you are a trustworthy person and do, in fact, have the ability to pull money out of your own account or get it from someone or something else in order to provide the down payment (if required) and the monthly payments.
Please do note that while Mr. or Mrs. Seller may be more relaxed with the underwriting, you do absolutely want to be sure that you can pull this off. It does not do anyone any good to tie up a seller and then not be able to execute. The seller will normally have the power to foreclose on you just like a bank would if you start missing payments (via the governing agreement for the transaction).
You can close the deal quickly. Once you have agreed on a price and terms and the governing contract has been looked over by your attorney, you are effectively a brand new owner of a property.
No or Low Down Payment
Ah yes, the dreaded down payment. Mr. or Mrs. Seller, in most cases, will not hold you to the normal 20 or 25 percent down that most banks want. Most likely, he or she will not be calculating your debt-to-income ratio as it relates to your down payment and the effect it has on your monthly obligations.
Is this not what most people struggle with when buying with traditional financing? Instead, with owner financing, all of the terms are up to the buyer and the seller. You determine what is required to be handed over up front, if anything. Maybe the seller really wants a used Prius, so they require $10,000 down. Maybe he or she has $7,800 in credit card debt that they’re looking to get rid of.
With owner financing, it is important to figure out the seller’s motivation. From there, you can start to craft the terms of the deal.
What Buyers Should Know About Down Payments
Here is some bonus information about down payments: If you want to borrow the down payment, go for it. Can you do it with a bank? Maybe. But when I have tried in the past, I was shut down. When I did it with an owner-financed deal, nobody even blinked.
What Buyers Should Know About Interest
In addition, you have complete free range to negotiate the interest rate. On one of my first deals, I had a 10 percent interest rate—not my best negotiation. But for my second owner-financed deal, I was at 5 percent. Getting better!
Example of Owner Financing
A while ago, I found an off-market deal in Connecticut. The market was smoking hot in this particular area and I knew the town like the back of my hand. I knew he was asking about $50,000 too little. I jumped on it.
Come to find out, he did have a personal loan or two that were really bothering him. The total of those loans was about $22,500. That amount ended up being the down payment. The agreed upon purchase price was $170,000. That is 13.2 percent down—a far cry from what banks want.
It took 30 days to close. That did run a little bit long. It was due to our attorneys going back and forth with all the legalese. But I suppose it is important to make sure the contract is done right and is fair to both parties.
If you are looking for another way to get into the game without losing the shirt on your back or the girth of your wallet, take a close look at this strategy. Ask the same first questions of sellers that I ask. What is the worst that can happen?
What other questions can I answer for you about owner financing?
Ask me in the comment section below.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.