Have you ever been turned down for a mortgage home loan because you cannot meet the strict lending guidelines? Some of the reasons why a buyer may be turned down for traditional lender financing include:

• Poor credit
• Insufficient work history
• Self-employment
• High debt-to-income ratios
• Recent divorce
• Past bankruptcy
• Short sale history

Have you heard people talk about "owner financing" but were not quite sure about it? Keep reading to find out what owner financing is and the pros and cons of owner financing for buyers.

What Is Owner Financing?

Owner financing, also referred to as seller financing, is where the owner of the house finances the purchase of the house for the buyer. A house can cost a lot of money, right? Some say it is the largest single investment a person will ever make. However, not everyone can qualify for a traditional mortgage home loan with a traditional mortgage broker or lender due to the strict lending guidelines. 

Because there are no restrictions on who can use owner financing or what type of property can be bought or sold with it, many investors use owner financing to buy or sell properties. Although owner financing is used frequently by real estate investors, it can also be used if a buyer doesn't qualify for traditional financing because of poor credit, insufficient work history, self-employment, previous bankruptcy or foreclosure, or various other economic factors that do not meet the strict guidelines of a traditional mortgage lender.

How Does Owner Financing Work?

When the owner finances the house for the buyer, the owner is essentially extending credit to the buyer to cover the purchase of the house minus the down payment which is typically around 10 percent or more. There are several types of owner-financing structures that can be used, and it is very important that the buyer understands the difference. Here are a few of them.

• Promissory note and deed of trust
• Contract for deed
• Lease option 

Promissory Note and Deed of Trust

A promissory note and deed of trust is considered the most secure form of owner financing for both the seller and buyer as it is the same structure a bank would use to lend on a property. The buyer signs a promissory note to the owner-seller that defines the terms of the loan such as the interest rate, the repayment schedule, and the consequences of defaulting on the loan. The buyer then makes regular periodic payments as defined in the installment agreement until the loan amount is paid in full. The buyer is recorded on the deed. The deed of trust secures the loan for the seller. The promissory note and the deed of trust are recorded in public records.

Contract for Deed

A contract for deed is a contract between an owner-seller and a buyer whereby the owner of property retains the title or deed of the property until the buyer finishes making the installment payments of the agreed-upon purchase price. There is no promissory note in a contract for deed. There are some owner-sellers who prefer the structure of a contract for deed because it can be quicker and less costly to regain the property in the event that the buyer defaults. 

Lease Option

Sometimes referred to as "rent-to-own", a lease option begins with the buyer leasing the house for a period of time with the option to buy in the future. Before the lease starts, the buyer and owner-seller agree on the purchase price of the house. When the lease expires, the buyer can then choose to buy the house or forfeit the option fee and any other fees the buyer may have paid to enter into the lease-option agreement. If the buyer does choose to buy the house, the option fee is usually applied like a down payment towards the purchase price of the house. However, the lease payments made before the option was exercised DO NOT typically apply towards the purchase price of the house.

Contracts for deed and lease option agreements are heavily regulated by the State of Texas because they are viewed as potentially predatory. All buyers should seek legal advice when using owner financing.

Owner Financing Terms

The owner and the buyer determine the terms of the deal. This includes the amount of the down payment, the interest rate, the length of the loan, and if there will be a balloon payment at the end of the term. Most owners already have specific terms in mind, so there is not necessarily much negotiation. However, the terms do need to be defined, discussed, and decided upon by both parties. It is very important that the buyer thoroughly understands the terms of the agreement especially when there is a balloon payment involved.

Down Payment

The down payment is the amount of money the buyer pays up front to the owner, and it is typically around 10 to 20 percent of the purchase price. A higher down payment shows that the buyer has "skin in the game" meaning the buyer is less likely to default on the loan.  

Interest Rate

The interest rates for owner-financed loans are almost always much higher than what traditional lenders would offer. Because the owner takes on risk by financing the house for the buyer, the owner offsets the risk by charging a higher interest rate.

It is not uncommon to see interest rates of 8% or higher. Texas, like most states, has usury laws which regulate the maximum interest rate that may be charged on a loan. Loans can have an adjustable interest rate, a fixed interest rate, and some loans can be interest-only loans. Again, it is very important for a buyer to understand the terms of the agreement.

Adjustable-rate mortgage (ARM) loan

The interest rate of the loan may change periodically, as the rate is often tied to the prime rate or other index rate. There are also occasions where the owner-seller and buyer agree to specific step up rates which will occur during the life of the loan. 

Fixed-rate loan

Fixed rate loans have an interest rate that does not change over the life of a loan, meaning it does not go up or down with the prime rate or other index rate. You pay the same amount each month, and the principal balance of the loan is paid down gradually with regular periodic payments. 

Interest-only loan

For a set period of time, the buyer pays interest only then makes a large balloon payment toward the principal at the end of the set term. Interest-only loans mean lower payments for a period of time, but they also mean you are not building equity by paying down principal. There can be a big jump in payment amount when the interest-only period ends. Interest-only loans are often used by investors for fixing and flipping properties.

Length of Loan

The length of the loan is the time over which the buyer will repay the loan. It can be five, 10, 15, 20, or 30 years or anything really. In owner financing, it is not uncommon to see shorter terms such as five or 10 years with a balloon payment at the end of the term. Owners often finance properties for buyers with the expectation that the buyer will refinance the house with a traditional lending product. Sometimes, an owner-financed loan can be amortized over a longer period of say 30 years but the length of the loan term is set to 10 years. This keeps the buyer's monthly payment low, but it also means less principal is being paid down during that time.

Balloon Payment

A balloon payment is a LARGE, one-time lump sum payment made at the end of a loan. It is very important that a buyer understands whether or not a balloon payment is part of the loan agreement. If the buyer cannot make the balloon payment, he or she may be forced to sell the house quickly (potentially at a loss) or default on the loan if he or she is still not qualified to refinance with a traditional mortgage home loan.

Balloon payments are not uncommon with owner-financed loans. Owner-sellers very seldom want to wait a full 20 or 30 years to get their money back. Also, these payments can increase the return for the owner-seller.

Owner financing can be a good and only option for a buyer who cannot qualify for a mortgage home loan with a conventional lender. However, it is important to weigh the pros and cons of owner financing.

Owner Financing is Often a Short-Term Scenario

Many owner-financing deals are short term, because most owners are not willing to wait decades to get their money back. A typical arrangement is to amortize the loan over 30 years to keep the monthly payments low with a final balloon payment due after about five or 10 years. The assumption is that after five or 10 years the buyer will have enough equity in the house or enough time to improve their financial situation to qualify for a traditional mortgage home loan.

Owner Financing Example With a Balloon Payment

Let's say a seller owns a house outright. The seller lists the house for sale for $200,000 and is willing to owner finance a buyer. The owner-seller and buyer define, discuss, and decide on the terms of the agreement. While the owner is willing to finance the buyer, the owner does not want to wait 30 years for repayment, and the buyer is trying to keep the monthly payments low to pay down other debts. So, the owner offers a 15-year note based on a 30-year amortization with a balloon payment due at the end of the 15th year. Remember, this means lower monthly payments but a sizeable balloon payment will be due at the end of the installment term. 

Owner Financing Example With Numbers

Let’s look at a realistic traditional owner finance example with a promissory note and deed of trust. There is a down payment of 10%, a 30-year amortization period and a balloon payment due for the remaining balance due in year 15. Here is what a balloon mortgage calculator shows. (Note: the terms mortgage and note are used interchangeably here.)

Asking Price $200,000

Down Payment $20,000

Amount Financed $180,000

Interest Rate 9%

Amortization 30 years

Balloon at 15 years

Monthly Payment (principal & interest) $1448.32

Balance due at time of balloon $142,794.80

Total of All Payments to Seller (down payment + monthly payments 

for 15 years + balloon payment) $423,492.40

Owner Financing Documents

To set up an agreement for owner financing, either the owner-seller or the buyer will have several forms of paperwork drafted by a real estate attorney. The three documents that will be drafted and signed in this example are the promissory note, a deed of trust and a warranty deed.  Because this scenario involves a promissory note and deed of trust, the buyer will receive the title at closing. 

Promissory Notes

A promissory note is the promise to pay for the property and spells out the loan terms and expectations for repayment. It includes the following information about the agreement:

• Amount of debt
• Term of repayment
• Interest rate
• The repayment schedule
• Frequency of payments like monthly or quarterly
• Payment amount which may be principal and interest or if it takes another form
• Tax and insurance payment responsibilities
• Balloon payment if one is involved and what the specifics are

A promissory note will also detail the penalties for late payments, any prepayment penalties, and whether the loan balance may be due in full if you sell the property (called a due-on-sale clause). 

Deed of Trust

A deed of trust is the instrument that creates a lien on the house to secure a promissory note. 

Warranty Deed

The warranty deed is the instrument that transfers the property to the Buyer.

After five years of timely monthly payments, the buyer makes the final LARGE balloon payment to the seller, and the lien is released. The deed of trust provides security for the seller. In effect, it places a lien on the property and provides for remedies if the buyer default on payments. 

The documents are filed at the local courthouse to ensure there’s a legal record of the lien, expectation of repayment, and provide the basis for foreclosing if the seller finds it necessary. 

Pros and Cons of Owner Financing

Owner financing can be a good option for buyers who cannot otherwise secure a loan to purchase a house. 

Pros for Buyers

Easier qualification: A good option for buyers who cannot qualify for a traditional mortgage home loan due to strict lending guidelines

Faster closing: No waiting for a bank loan officer, underwriter, and legal department to process and approve the buyer's application

Cheaper closing costs: No bank fees, inspection, or appraisal costs (unless the buyer chooses to have an inspection and appraisal)

Cons for Buyers

Larger down payment: Most owner finance deals require at least a 10% down payment

Higher interest: The loan interest rate will be higher that what would be paid to a bank

Need owner approval: Even if an owner is willing to owner finance the house, the owner will still have to qualify the buyer

Balloon payment: The owner may not be willing to hold the note for more than five or 10 years. If not, the note commonly comes due in the form of a balloon payment. The buyer must pay the balloon payment in cash or by refinancing the property. Otherwise the buyer risks losing all the money paid thus far including the initial down payment plus the property itself.

Taxes and Insurance: Unlike a traditional mortgage home loan, property taxes and insurance may not be rolled into monthly payment. If they are not, the buyer must pay those bills outside of but in addition to the monthly installment payment.

Due-on-sale clause: If the seller still has a mortgage home loan on the property, then the sellers lender can demand immediate payment of the debt in full if the house is sold to someone else (to you). Most mortgage home loans have a due-on-sale clause. If the lender isn’t paid, then the seller's bank can foreclose. To avoid this risk, make sure that the seller owns the house free and clear or that the seller’s lender agree in writing to owner financing.

Before Considering Owner Financing

Before considering owner financing it is important that a buyer consider the pros and cons. The process can be complex so working with a licensed attorney who specializes in real estate is highly advisable. A licensed attorney who specializes in real estate will consider your best interests when drafting or reviewing the necessary documents. A REALTOR® may help you in finding a house, but a REALTOR® cannot give legal advice.

About the author: The above real estate information on the Advantages of a Buyer Representation Agreement was provided by Krista Jenkins, a Lubbock, Texas REALTOR®. Krista can be reached via call or text at 806-928-4359. Krista has helped people move in and around the Lubbock, Texas area for the last 7+ Years.

Are you thinking of buying or selling a house in Lubbock, Texas or the surrounding area? I have a passion for real estate and would love to share my buying, selling, and investing expertise with you!

I practice real estate in the following West Texas towns: Lubbock, Idalou, New Deal, New Home, Ransom Canyon, Shallowater, Slaton, and Wolfforth TX.

Employing the services of an experienced Texas REALTOR® is similar to using a credentialed accountant to prepare your taxes, a board-certified doctor to care for your health issues, or a certified mechanic to repair your car. If you had the time to devote to learning accounting, medicine, and automotive mechanics, you could perform these services for yourself. Right? But who has the time? This is why you employ the experts.

Your Interests Are Professionally Represented

Employing an experienced Texas REALTOR® allows you to concentrate on your full-time job, while we concentrate on our full-time job...REAL ESTATE. An experienced Texas REALTOR® will guide you through the home-buying process, which has the following advantages:

• Finding the best property that meets your needs more quickly and conveniently
• Formulating a fair offer based on current market research
• Presenting your offer to the listing agent in a professional and timely manner
• Organizing the due diligence process to include primary and secondary inspections
• Renegotiating an offer based on outcome of due diligence process
• Facilitating the timely closing of your new home
• Representing your best interests exclusively throughout the process

Just as your credentialed accountant, board-certified doctor, and certified mechanic understand your specific needs, your experienced Texas REALTOR® thoroughly explores your real estate needs and concerns. This type of relationship is built on open and honest communication. Your REALTOR® can save you money, time, and headaches as your REALTOR® takes care of the “heavy lifting” of the home-buying process.

Why Should I Sign a Buyer Representation Agreement?

Signing a Buyer Representation Agreement, also known as a Buyer Agency Agreement, with an experienced Texas REALTOR® has countless advantages. By signing the agreement, you are hiring an agent who, by law, must represent your best interests to the best of his or her ability. This personal service comes at no direct cost to you as it is the listing agent who shares his or her fee which has already been negotiated with the seller.

Both agents are paid at closing through the seller's proceeds. With buyer representation, you employ a professional devoted to protecting you and your money. After all, purchasing real estate is one of the most important investment decisions of your life.

Understanding Agency - Who Works for Whom?

Seller Agency (Single Agency)

• Agent represents the best interests of the seller
• Agent owes the seller fiduciary duties
• Agent must give the seller all material facts, so the seller can make an educated decision

Buyer Agency (Single Agency)

• Agent will represent the best interests of the buyer
• Agent will owe the buyer fiduciary duties
• Agent must give the buyer all material facts, so the buyer can make an educated decision

Intermediary Agency Without Appointment (Transaction Broker)

• Agent represents both the buyer and the seller equally
• Agent’s objective is to get a mutually satisfactory agreement among all parties but cannot offer an opinion
• Agent gives all options to both the buyer and the seller
• All parties may be present at contract presentation to negotiate on their own behalf
• All parties are due confidentiality and agent may do nothing to the detriment of either the buyer and the seller
• Both the buyer and the seller have a right to counsel. Before making any decisions, both parties have the right to seek family, legal, financial counsel, or whatever counsel they deem appropriate

A Dedicated Representative Guides You Through the Entire Process

Texas REALTORS® are neighborly with other agents, trusted advisors to their real estate clients, a resource for local vendors (lenders, inspectors, surveyors, contractors, etc.), and expert navigators of the local real estate market.

Texas REALTORS® are members of the National Association of REALTORS® (NAR) and the Texas Association of REALTORS® and agree to abide by a strict Code of Ethics and Standards of Practice. We are experts in our field and trusted resources for Texas home buyers.

To recap, an experienced Texas REALTOR® 

• Can save you time, money, and frustration
• Knows the housing market inside and out and can help you avoid the “wild goose chase”
• Can assist you with any home, even if it is listed by another agent and sometimes For Sale By Owner
• Knows  the best lenders in the area and can help you understand the importance of being prequalified for a mortgage and can  discuss down payments, closing costs, and monthly payment options that suit you
• Can present your best offer to the homeowner and help you navigate the process of renegotiating based on due diligence
• Bring objectivity to the buying transaction, in other words we can point out the advantages and the disadvantages of a particular property

Remember, buying a home is a major endeavor, and some say it is the biggest single investment a person will ever make. Enjoying a successful real estate transaction requires knowledge and experience, the knowledge and experience of a Texas REALTOR®. We are committed to understanding your needs and helping you achieve your goals.

About the author: The above real estate information on the Advantages of a Buyer Representation Agreement was provided by Krista Jenkins, a Lubbock, Texas REALTOR®. Krista can be reached via call or text at 806-928-4359. Krista has helped people move in and around the Lubbock, Texas area for the last 7+ Years.

Are you thinking of buying or selling a house in Lubbock, Texas or the surrounding area? I have a passion for real estate and would love to share my buying, selling, and investing expertise with you!

I practice real estate in the following West Texas towns: Lubbock, Idalou, New Deal, New Home, Ransom Canyon, Shallowater, Slaton, and Wolfforth TX.

It is normal for people to have lots and lots of questions before, during, and even after the home buying process. This is especially true with first-time home buyers. You should never be afraid to ask questions. In fact, it is your RIGHT and RESPONSIBILITY to ask as many questions as you feel are necessary to make an educated decision about your loan and the home you are purchasing. Below are ten commonly asked questions.

What is the first step of the home buying process?

Honestly? Research. Buying a house can require a lot of time and effort. It is important that you understand how to find and finance the best house for you. Following are some of the things you can do to begin your research.

• Conduct an internet home search starting with this website. Take note of the types of houses you like and the areas in which you would prefer to look.
• Ask your friends, family, and/or co-workers what they like or dislike about their neighborhoods.
• Get an idea of what you can afford by asking your favorite REALTOR® for a list of preferred mortgage brokers and lenders and speaking to one.
• Research the types of mortgage loans available and ask the mortgage broker or lender about which one is right for you.

What credit score do I need to qualify for a mortgage loan?

Loan requirements change frequently, but a credit score of 620 or higher is generally recommended. A higher credit score offers better lending terms. However, there are lenders who will work with buyers with 580 credit score. Ask your favorite REALTOR® for a list of preferred mortgage brokers and lenders as they will be your best source for current lending requirements.

How will I know how much home I can afford?

After you have asked your favorite REALTOR® for a list of the most friendly and knowledgeable mortgage brokers and lenders in the business, choose one. Because unless you are paying cash for a property, you will need to apply for a mortgage. After speaking to a mortgage broker or lender and providing some basic information about your income and savings and investments, you will be issued a prequalification letter. This letter will tell you how much the lender is willing to lend to you based on the information you have provided. 

Are there special mortgage loans for home buyers? 

Based on your research, you probably know there are two main varieties of mortgage loans to use when buying a home: conventional mortgages and government-backed mortgages (FHA, USDA, and VA). Your REALTOR® and mortgage broker or lender can help you understand the difference between these loans and which one may best suit your needs. Some entities even offer down payment assistance if certain conditions are met. 

Do I need money for a down payment?

It depends. Down payments can range from 0% to 20% depending on the home you are purchasing and the loan you choose. Conventional loans can vary from 3% to 20%.  FHA loans just dropped their requirement from 3.5% to 3%. Eligible veterans can apply for a VA loan which requires no money down. Rural properties areas are usually eligible for a USDA loan financing which also requires no money down.

What do I need to apply for a mortgage?

After you have chosen a mortgage broker or lender and have been issued a prequalification letter you will still have to fully apply for a mortgage. Following is a general list of documents you will need from each person applying for the mortgage. Your lender will use these documents to verify your financial status and credit.

• Social Security card
• Valid driver's license or government-issued photo ID
• Address(es) from the past two years
• Employment history for the past two years
• Pay stubs from your current job
• W-2 forms for the past two years and K-1 forms (if applicable)
• Tax returns from the past two years
• Profit & loss statement and balance sheet (if self-employed)
• Bank statements from the past two months
• Investment account statements from the past two months
• Retirement account statements from the past two months
• Make and model of vehicles you own and their resale value
• Credit card account information
• Personal loan account information

What do REALTORS® actually do?

We herd cats. Just kidding. Seriously though, sometimes we do literally herd cats, dogs, chickens, but that is a story for a different day....

A REALTOR® can be your most valuable asset when buying a home beginning with the list of friendly and knowledgeable mortgage brokers and lenders. This is where we begin to walk you through every part of the home buying process. Showing homes is the smallest part of what we do for our clients. Our most important job is to educate and inform you of all your options before, during, and sometimes after the home buying process. When you hire a REALTOR®, you are employing that REALTOR® to represent YOUR BEST INTEREST in the transaction. 

How long does it take to find a home?

The timeline for finding a home varies greatly from person to person. If you have done your research, know where you prefer to live, have a reasonably good idea of the type of home you want, and know how much you qualify to borrow, the process can take less than 90 days if there is a consistent inventory of homes available that meet your wants, needs, and budget. 

How long does it take to buy a home?

After your REALTOR® has assisted you in finding a house, submitting an offer, and getting the offer accepted, it takes anywhere from 30 to 60 days to close depending on the circumstances. 

Do I have to pay my REALTOR® as a home buyer?

In most cases, you do not have to pay your REALTOR® anything but patience and gratitude to assist you in buying a home. When a seller lists their home for sale with a REALTOR®, they agree to pay the listing REALTOR® a certain commission. If a separate REALTOR® brings a buyer to purchase the listed home for sale, the listing REALTOR® agrees to share the commission with the buyer's REALTOR® at closing. 

If you have any other real estate questions you would like answered, please feel free to contact us directly or leave a comment below for others to answer as well. A great REALTOR® is your very best source of accurate information when it comes to buying a home. Once you have found a great REALTOR®, ask as many questions as possible. A great REALTOR® will gladly and patiently walk you through each step of the home buying process.

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