Buying or selling a home can be a complicated process. Sometimes, homebuyers have trouble qualifying for a mortgage. Other times, sellers yearn to cut through the red tape and net potentially more profit.
The solution for both may be owner financing. Although not very common today, owner financing is when the seller offers direct financing to the buyer instead of or in addition to a mortgage.
What is owner financing?
Owner financing occurs when the owner of a property for sale provides partial or complete financing to the buyer directly, after the buyer makes a down payment, according to Michael Foguth, founder and president of Foguth Financial Group in Howell, Michigan.
“The agreement here is very similar to a mortgage loan, except the owner of the home owns the debt instead of a bank or other lender,” Foguth says.
Owner financing is usually not reported on the buyer’s credit report. There is typically a substantial down payment required (usually 10 percent to 15 percent) that makes up for the fact that the financing is usually not dependent on the buyer’s income or credit history — although sellers are advised to perform a credit check regardless.
Chris McDermott, real estate investor and broker with Jax Nurses Buy Houses in Jacksonville, Florida, has offered owner financing himself on investment properties he’s sold. McDermott says it can be a common practice in some areas, “specifically for rural land or homes that a seller owns free and clear.”
Owner financing can be beneficial to buyers who aren’t eligible for a desired loan from a lender, or if the lender only qualifies the buyer for a portion of the purchase price. In the latter scenario, the buyer may be able to take out a first mortgage from the lender for that portion, and then obtain owner financing for the shortfall.
How does owner financing work?
In most owner financing arrangements, the owner (seller) records a mortgage against the property, which is sold via deed transfer to the buyer.
“Typically, the owner lets the buyer take over and move into the house without a mortgage, but after the buyer makes a down payment,” explains Andrew Swain, co-founder and president of Sundae, a San Francisco-headquartered residential real estate marketplace that helps sellers of distressed properties.
“The buyer signs a promissory note and makes monthly payments to the seller, but the owner keeps the title to the home as leverage in the deal,” says Swain.
“The buyer makes mortgage payments to the seller over an agreed-upon amortization schedule at a specified fixed interest rate,” McDermott says. “Typically, the seller will not hold that mortgage for longer than five or 10 years. After that time, the mortgage commonly comes due in the form of a balloon payment owed by the buyer.”
To make that balloon payment — generally a large lump sum — the buyer usually (by that time) qualifies for and obtains a mortgage refinance, likely for a lower interest rate.
Alternatively, the buyer can get a first mortgage from a bank or other lender while the seller takes a second interest in lieu of some of the down payment, explains John Kilpatrick, managing director of Greenfield Advisors in Seattle.
“Say you want to buy a $200,000 house,” Kilpatrick says. “The bank will only loan you $160,000. If the seller will take back a second mortgage for $40,000, the deal may be able to close.”
Just because a seller is providing the funds doesn’t mean the buyer won’t pay closing costs, however. According to McDermott, these charges can include deed recording and title fees.
The good news is that the costs “are usually substantially less than you’d pay with bank financing,” says Bruce Ailion, a real estate attorney, investor and Realtor in Atlanta.
Example of owner financing
Say “a seller advertises a home for sale with owner financing offered,” McDermott says. “The buyer and seller agree to a purchase price of $175,000. The seller requires a down payment of 15 percent — $26,250. The seller agrees to finance the outstanding $148,750 at an 8 percent fixed interest rate over a 30-year amortization, with a balloon payment due after five years.”
In this example, the buyer agrees to make monthly payments of $1,091 to the seller for 59 months (excluding property taxes and homeowners insurance that the buyer will pay for separately).
At month 60, a balloon payment of $141,451.27 will be due. The seller will end up collecting $233,161.27 after 60 months, broken down as:
$26,250 for the down payment
$58,161.27 in total interest payments
Total principal balance of $148,750
Pros and cons of owner financing
Access to financing for homebuyers
Benefits for sellers at tax time
Bigger down payment required
Homeowner sells as-is, without paying for repairs
Higher interest rate
Greater investing potential for sellers
Risky for seller if buyer defaults
Owner financing offers advantages and disadvantages to both the buyer and seller.
“The buyer can get a loan they otherwise could not get approved for from a bank, which can be especially beneficial to borrowers who are self-employed or have bad credit,” Ailion says.
However, “the interest rate charged by a seller is usually much higher than a traditional mortgage lender would charge,” McDermott says, “and the balloon payment that comes due after a few years will be significant.”
The advantages to the seller are multifold. Owner financing allows the seller to sell the property as-is, without any repairs needed that a traditional lender may require.
“Additionally, sellers can obtain tax benefits by deferring any realized capital gains over many years, if they qualify,” McDermott notes, adding that “depending on the interest rate they charge, sellers can get a better rate of return on the money they lend than they would get on many other types of investments.”
The seller is taking a risk, though. If the buyer stops making loan payments, the seller may have to foreclose, and if the buyer didn’t properly maintain and improve the home, the seller could end up repossessing a property that’s in worse shape than when it was sold.
How to buy a home with owner financing or offer it
If you can’t get the financing you need from a bank or mortgage lender, a skilled real estate agent can help you find properties with owner financing.
“Just be sure the promissory note you sign is legally compliant and clearly lays out the terms of the deal,” advises Swain. “It’s also a good idea to revisit a seller financing agreement after a few years, especially if interest rates have dropped or your credit score improves — in which case you can refinance with a traditional mortgage and pay off the seller earlier than expected.”
If you want to offer owner financing as a seller, you can mention the arrangement in the listing description for your home.
“Be sure to require a substantial down payment — 15 percent if possible,” McDermott recommends. “Find out the buyer’s position and exit strategy, and determine what their plan and timeline is. Ultimately, you want to know the buyer will be in the position to pay you off and refinance once your balloon payment is due.”
It’s important to have a real estate attorney prepare and carefully review all the documents involved, as well, to protect each party’s interests.
NEW PALTZ, N.Y. — The village is considering expanding eligibility for a little-used revolving loan fund to include the needs of businesses being hit hard by the COVID-related economic slowdown.
Mayor Tim Rogers said Tuesday that the $500,000 loan fund could be used to help businesses with more than just the purchase of personal protective equipment allowed under state and federal programs.
“We’re trying to piggyback off of the existing language for the revolving loan fund,” he said. “We just wanted to make it somewhat broad in terms of recognizing COVID impacts.”
One thing the village is considering is eliminating the rule that prohibits the use of the fund for emergency situations or business operations.
“Here we are flipping it and saying that you can,” Rogers said.
Guidelines for the loan program, which was established with funding from the U.S. Department of Housing and Urban Development, were last updated in 2013. The loan fund’s current interest rate is 3%.
Rogers said the fund has received only two loan applications over the past six years, and one of those was rejected.
“There’s only been one that we awarded and one that we straight up denied,” he said, noting that the rejection was because of the applicant’s bad credit history.
Rogers said the COVID-19 pandemic has created something of an economic irony in the village: decreased foot traffic in the business district but a significant increase in applications for building permits.
“[Village Safety Inspector] Cory Wirthmann believes our busy Building Department is partially a function of people traveling or vacationing less,” the mayor said. “ Money they would have spent is now going to home improvement wish list projects or just deferred maintenance, like finally choosing to replace the old roof.”
The short answer is yes: skipping one car payment can hurt your credit score, but not until it hits a certain mark. One missed payment doesn’t destroy your credit score forever, but it can stay on your credit reports for years.
Missed Payments and Your Credit Score
One or two missed payments may not be enough to completely ruin a good credit score, but they can lower your credit score quite a bit. How much your credit score can drop depends on many things, including how much credit history you have and how much time has passed since your missed payment.
How much a missed payment can impact your credit score is heavily influenced by how many missed payments you currently have reported, your current credit score, your credit utilization, how many accounts you have, and more. In other words: your drop in credit score due to one missed car payment is likely to be unique to you. The drop in points could be anywhere from 10 to 100 points, or more.
If you have a thin credit file or little to no credit history, one missed car payment can be devastating to your credit score. And, in some cases, having a good credit score and then a reported 30-day missed payment could hurt your credit score more because you have more to lose.
The severity of the missed payment matters too. If you’re 30 days on the payment, it’s not as bad as being 90 days late. Most creditors report missed payments in these timeframes: 30 days; 60 days; 90 days; 120 days; 150 days; and then delinquent/charge-offs after that. The longer you let that missed payment go on being missed, the worse it is for your credit score.
To bounce back from a missed auto loan payment, be sure to make that payment as quickly as you can. The sooner you make up that payment, the better off you are.
How Long Are Missed Car Payments Reported?
Missed and late car payments can remain on your credit reports for up to seven years. How much they damage your credit score lessens each year, but it can still impact your overall credit score years afterward.
Your payment history is the most influential part of your credit score: a whopping 35%. In terms of credit repair, this means making all of your bill payments on time is important. If you have an auto loan that isn’t currently being reported – meaning your loan and on-time payments don’t show up on your credit report – the missed and late payments are likely to be reported anyway. Even auto lenders that don’t generally report their loans to the credit bureaus typically report missed/late payments.
If you think you’re about to miss a payment and you want to avoid hurting your credit, you have some options to explore.
Ask Your Lender for a Deferment
Lending institutions understand that times can get tough. If you think you’re about to miss a payment, contact your lender right away and ask what options are available to you. Keep your lender in the loop if you’re going through rough times – the sooner you get ahold of them the better.
This is especially true right now, given the current pandemic. Many borrowers left without work have been forced to find alternatives to making payments and needed assistance with their car loans and mortgages. There is a process that allows borrowers to take a breather and gather themselves, and it’s called a deferment.
A deferment, in a nutshell, pushes the pause button on your auto loan. Most times, lenders pause the car payments for up to three months and add those payments to the back of the loan term. If you qualify, you may be able to recenter yourself and get back on track. After the deferment is up, the car payments resume and you continue paying as normal.
The only downsides to this option are that your interest charges continue to accrue, and your loan term is extended. However, in the grand scheme of things, a few more months of a car payment and interest charges is better than default or multiple missed payments!
There is a common stumbling block to deferments though: most lenders don’t approve these plans unless your current on the loan. If you’ve already missed one payment or more, then the lender isn’t likely to approve it.
Is Refinancing Your Auto Loan an Option?
If you’re struggling to keep up with your current car loan, refinancing for a lower monthly payment could be the answer.
Refinancing involves replacing your current loan with another one, typically with a different lender. Most borrowers refinance to lower their monthly payments by either lowering their interest rate or extending their loan term (sometimes both).
Must have equity in the car or the loan balance must be equal to the vehicle’s value
The car is under 10 years old with fewer than 100,000 miles
Your credit score has improved since the start of the loan
You may need to meet other requirements, depending on the lender you choose. Refinancing doesn’t typically require a “perfect” credit score, but you may need a good one to qualify.
Ready to Get a More Affordable Car?
If you’re struggling to make ends meet and worried about skipping payments, then it may be time to sell your car and get something more affordable. If you’re concerned that a poor credit score could get in the way of your next auto loan, then consider a subprime lender through a special finance dealership.
Subprime lenders are indirect lenders that are signed up with certain dealers. They assist borrowers in all sorts of unique credit circumstances, and they could help you get into a more affordable vehicle if you qualify.
Finding a subprime lender can be as simple as completing our free auto loan request form. Here at Auto Credit Express, we work to match borrowers to dealerships with bad credit lending resources in their local area, at no cost and with no obligation. Get started today!
Look at you, so responsible. You received a financial windfall — stimulus check, tax refund, work bonus, inheritance, whatever — and you’re using it to pay off one of your debts years ahead of schedule.
Good for you! Except… make sure you don’t get charged a prepayment penalty.
Now wait just a minute, you say. I’m paying the money back early — early! — and my lender thanks me by charging me a fee?
Well, in some cases, yes.
A prepayment penalty is a fee lenders use to recoup the money they’ll lose when you’re no longer paying interest on the loan. That interest is how they make their money.
But you can avoid the trap — or at least a big payout if you’ve already signed the loan contract. We’ll explain.
What Is a Loan Prepayment Penalty?
A prepayment penalty is a fee lenders charge if you pay off all or part of your loan early.
Typically, a prepayment penalty only applies if you pay off the entire balance – for example, because you sold your car or are refinancing your mortgage – within a specific timeframe (usually within three years of when you accepted the loan).
In some cases, a prepayment penalty could apply if you pay off a large amount of your loan all at once.
Prepayment penalties do not normally apply if you pay extra principal in small chunks at a time, but it’s always a good idea to double check with the lender and your loan agreement.
What Loans Have Prepayment Penalties?
Most loans do not include a prepayment penalty. They are typically applied to larger loans, like mortgages and sometimes auto loans — although personal loans can also include this sneaky fee.
Credit unions and banks are your best options for avoiding loans that include prepayment penalties, according to Charles Gallagher, a consumer law attorney in St. Petersburg, Florida.
Unfortunately, if you have bad credit and can’t get a loan from traditional lenders, private loan alternatives are the most likely to include the prepayment penalty.
If your loan includes a prepayment penalty, the contract should state the time period when it may be imposed, the maximum penalty and the lender’s contact information.
”The more opportunistic and less fair lenders would be the ones who would probably be assessing [prepayment penalties] as part of their loan terms,” he said, “I wouldn’t say loan sharking… but you have to search down the list for a less preferable lender.”
Prepayment Penalties for Mortgages
Although you’ll find prepayment penalties in auto and personal loans, a more common place to find them is in home loans. Why? Because a lender who agrees to a 30-year mortgage term is banking on earning years worth of interest to make money off the amount it’s loaning you.
That prepayment penalty can apply if you want to pay off your loan early, sell your house or even refinance, depending on the terms of your mortgage.
However, if there is a prepayment penalty in the contract for a more recent mortgage, there are rules about how long it can be in effect and how much you can owe.
The Consumer Financial Protection Bureau ruled that for mortgages made after Jan. 10, 2014, the maximum prepayment penalty a lender can charge is 2% of the loan balance. And prepayment penalties are only allowed in mortgages if all of the following are true:
The loan has a fixed interest rate.
The loan is considered a “qualified mortgage” (meaning it can’t have features like negative amortization or interest-only payments).
The loan’s annual percentage rate can’t be higher than the Average Prime Offer Rate (also known as a higher-priced mortgage).
So suppose you bought a house last year and then wanted to sell your home. If your mortgage meets all of the above criteria and has a prepayment penalty clause in the mortgage contract, you could end up paying a penalty of 2% on the remaining balance — for a loan you still owe $200,000 on, that comes out to an extra $4,000.
Prepayment penalties apply for only the first few years of a mortgage — the CFPB’s rule allows for a maximum of three years. But again, check your mortgage agreement for your exact terms.
The prepayment penalty won’t apply to FHA, VA or USDA loans but can apply to conventional mortgages — although the penalty is much less common than it was before the CFPB’s ruling.
“It’s more of private loans — loans for people who’ve maybe had some struggles and can’t qualify for a Fannie or Freddie loan,” Gallagher said. “That block of lending is the one going to be most hit by this.”
How to Find Out If a Loan Will Have a Prepayment Penalty
The best way to avoid a prepayment penalty is to read your contract — or better yet, have a professional (like an attorney or CPA) who understands the terminology, review it.
“You should read the entirety of the loan, as painful as that sounds, because lenders may try to hide it,” Gallagher said. “Generally, it would be under repayment terms or the language that deals with the payoff of the loan or selling your house.”
Gallagher rattled off a list of alternative terms a lender could use in the contract, including:
Sale before a certain timeframe.
Refinance before a term.
Prepayment prior to maturity.
“They avoid using the word ‘penalty,’ obviously, because that would give a reader of the note, mortgage or the loan some alarm,” he said.
If you’re negotiating the terms — as say, with an auto loan — don’t let a salesperson try to pressure you into signing a contract without agreeing to a simple interest contract with no prepayment penalty. Better yet, start by applying for a pre-approved auto loan so you can get a pro to review any contracts before you sign.
Do you have less-than-sterling credit? Watch out for pre-computed loans, in which interest is front-loaded, ensuring the lender collects more in interest no matter how quickly you pay off the loan.
If your lender presents you with a contract that includes a prepayment penalty, request a loan that does not include a prepayment penalty. The new contract may have other terms that make that loan less advantageous (like a higher interest rate), but you’ll at least be able to compare your options.
How Can You Find Out if Your Current Loan Has a Prepayment Penalty?
If a loan has a prepayment penalty, the servicer must include information about the penalty on either your monthly statement or in your loan coupon book (the slips of paper you send with your payment every month).
You can also ask your lender about the terms regarding your penalty by calling the number on your monthly billing statement or read the documents you signed when you closed the loan — look for the same terms mentioned above.
What to Do if You’re Stuck in a Loan With Prepayment Penalty
If you do discover that your loan includes a prepayment penalty, you still have some options.
First, check your contract.
If you’ll incur a fee for paying off your loan early within the first few years, consider holding onto the money until the penalty period expires.
If you don’t have a loan with a prepayment penalty, contact your lender before sending additional money to ensure your payment is going toward principal — not interest or fees.
Additionally, although you may get socked with a penalty for paying off the loan balance early, it’s likely you can still make extra payments toward the balance. Review your contract or ask your lender what amount will trigger the penalty, Gallagher said.
If you’re paying off multiple types of debt, consider paying off the accounts that do not trigger prepayment penalties — credit cards and federal student loans don’t charge prepayment penalties.
Tiffany Wendeln Connors is a staff writer/editor at The Penny Hoarder. Readher bio and other work here, then catch her on Twitter @TiffanyWendeln.
This was originally published on The Penny Hoarder, a personal finance website that empowers millions of readers nationwide to make smart decisions with their money through actionable and inspirational advice, and resources about how to make, save and manage money.