What Is Owner Financing?

Owner financing can allow you to buy commercial real estate after you’ve been turned down for a mortgage―but is it a good idea?

Last Updated: Less than 6 months
The recently funded Paycheck Protection Program offers small businesses a way to meet payroll needs with financial aid from the government. This aid is only being provided through the SBA and its authorized lenders. And businesses can receive a loan of up to $10 million to help cover payroll.

To access this loan, you’ll have to complete an application with an authorized lender that consists of a two-page form in addition to required documentation. If you qualify, you’ll be loaned 250% of your average monthly payroll in 2019. You may also qualify to have the loan forgiven if no employees are compensated above $100,000 and at least 75% of the money goes to paying workers. If you can’t obtain forgiveness, the loan must be repaid in two years at a 0.5% interest rate after six initial months of interest deferment.

If you think your business would benefit, apply at a Paycheck Protection Program authorized lender.

Owner financing goes by many names: seller financing, owner carryback mortgages, and owner will carry―to name a few.

But no matter the name, owner financing works the same way. Instead of getting a traditional mortgage from a bank, a buyer and seller come to an agreement in which the buyer makes payments directly to the seller.

Sounds simple, but there’s a lot you should know before you agree to owner financing as either a buyer or a seller. So let’s make sure you have the information you need.

Business vs. personal

Since this is Business.org, we’re focusing specifically on commercial real estate owner financing. But most of what we say applies to personal real estate too.

What is owner financing?

Owner financing provides an alternative to traditional commercial real estate loans. When buying a property, you agree to pay the seller directly rather than going through a bank or other lender.

For most buyers, owner financing isn’t their first choice. But getting a commercial mortgage isn’t always easy, and sometimes buyers get turned down for traditional loans. If you need the property but can’t get the loan to pay for it, what do you do? Well, you could give up―or you could turn to owner financing.

Partial owner financing

Some business owners use owner financing when they get a traditional loan, but it’s not big enough to cover the entire purchase cost. Partial owner financing can make up the difference.

So how does owner financing work? Well, once a buyer and a seller agree to go with owner financing, they have to come to agreement on the terms and conditions.

Just like a normal commercial mortgage, owner financing will have an amount that’s being financed, interest on that amount, a payment schedule, etc. In most cases, the seller will also require the buyer to make a down payment―again, just like a traditional mortgage.

Once they have that agreement, they make it formal. This takes the form of a promissory note, a document that lays out all those details, and a mortgage or deed of trust, which is essentially a lien on the property being sold.

After that, as with any loan, the buyer makes scheduled payments, and everyone’s happy. Or are they? Because as it turns out, owner financing isn’t right for everyone.

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Is owner financing right for me?

While seller financing can be great for some people―both buyers and sellers―you need to make sure you understand the cons as well as the pros.

Pros
  • Looser borrow requirements
  • Lower closing costs
  • Potential to negotiate
Cons
  • Shorter repayment terms
  • Large balloon payments
  • Lower chance of success
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On the one hand, owner financing can be a great option if lenders have turned you down for a mortgage. So if you have a bad credit score or banks have given the side-eye to your history of self-employment, seller financing might be one of your only options for purchasing commercial real estate.

Plus, it’s possible to save some money with owner financing. Seller financing doesn’t come with many of the expensive closing costs that you’d have with a traditional commercial mortgage. And you can always (try to) negotiate favorable interest rates and terms with the seller. Most lenders won’t let you do that.

You should know, though, that sellers often charge a higher interest rate than banks do (after all, the deal needs to be worth their while). And seller financing usually has a much shorter repayment term than a traditional mortgage does―think less than 15 years instead of up to 30 years.

That doesn’t necessarily mean your monthly payments will be out of control. Many sellers will calculate payments on a longer amortization schedule (the amount of time it takes to pay off a loan) and simply require you to make a balloon payment at the end of your agreed loan term.

Interest rates and terms

Let’s say you agree to a 10-year term. The seller might ask for monthly payments as though you have a 30-year term―but at the end of the 10 years, you have to pay whatever loan balance is left. This strategy can save you money in the short-term, but the balloon payment can be killer if you’re not prepared.

Of course, one of the biggest cons with seller financing is simply how hard it is to get. Many sellers have no interest in funding a buyer. After all, they’d rather get a lump sum of cash than accept smaller monthly payments over time. Plus, owner financing can be a big risk for sellers. They have no idea if you’ll actually make payments or if you’ll just default. (No offense. We’re sure you’re great.)

So even if owner financing sounds appealing, you might not have an easy time getting it.

Pros
  • Faster sale time
  • Potential to get more money
  • Monthly cash flow
Cons
  • Less up-front cash
  • Responsibility for loan management
  • Risk from unknown buyers

There’s one obvious reason that sellers like owner financing: it means you can sell a property much faster. You don’t have to wait for a buyer to go through a lengthy loan approval process, which takes weeks at minimum and months at most. Likewise, you won’t have to hold your breath during those weeks, hoping your buyer doesn’t get rejected for some reason.

Instead, you can just sell the property as soon as the legal documents get drawn up. So if time is of the essence, owner financing might hold some appeal for you.

Owner financing also gives you the potential to get more money in the long term. You’ll be getting not only the purchase price of the property but also interest on the money you lend―interest that, with a traditional mortgage, would go to a lender instead of your pocket. And depending on what kind of rates you agree on, that interest could really add up.

Of course, you’re sacrificing a large lump-sum payment to get that. Yes, you can still get some kind of down payment. But if you were hoping to use the property profits to, say, pay off your own commercial mortgage, the monthly payments of owner financing might be a problem.

Dodd-Frank Act

The Dodd-Frank Act limits how many owner financing deals you can do per year based on your business structure and other factors. So if you’re considering owner financing, you need to talk to a lawyer.

That being said, some business owners find they like the steady income of those monthly payments. It can be a good way to free up cash flow in your business.

In the end, though, the biggest con of owner financing is the responsibility and risk. Rather than hand off all the hard parts of lending to a bank, you’ll be personally responsible for making sure you get your mortgage payments. (You can hire a loan servicer to help with this part.)

And while a potential buyer might seem like a good person, there’s always the risk that they default on the loan. For a large mortgage lender, that’s an acceptable risk. They can absorb the cost, thanks to their size. But what about you? If a buyer bounces before paying off their loan, will you be fine? Or will you be in trouble? Make sure you know the answer before you opt for owner financing.

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How to get owner financing

Let’s say you understand the risks, and you still think owner financing is right for you. Then let’s break down the process briefly.

But before we do, we want to emphasize again that owner financing is a legal transaction. With potentially hundreds of thousands of your business’s dollars (or much more!) at stake, you need to make sure you get it right. So for the sake of your business and your sanity, talk with an attorney. Your own attorney―don’t assume the other party’s attorney has your best interests in mind.

Now that we’ve given you that reminder, here’s how owner financing works.

Is a commercial bridge loan a good idea?

As we’ve explained the ins and outs of commercial bridge loans, you’ve probably realized that they’re not right for everyone. But how do you know if bridge loans are right for you?

Background checks

Before you agree to owner financing as either a buyer or seller, it’s a good idea to do a background check on the other person.

First, of course, the buyer will need to find the property they want. Then the buyer and the current property owner will need to agree to owner financing.

The buyer and seller will negotiate and agree on specific details for the financing. These will include things like the financing amount, down payment amount, interest rate, and financing term. They’ll also need to agree on the amortization schedule and payment schedule. If there are any other fees or prepayment penalties, they’ll need to hash that out too.

Appraisals

Just because you’re not getting traditional financing doesn’t mean you should skip all the traditional steps. It’s a good idea―for both buyers and sellers―to get a property appraisal during the negotiation process.

Once they have an agreement, all those details need to be drawn up in a promissory note. Again, in most cases, it’s best to have an attorney do this.

While you can do it yourself or with online legal software, an attorney can make sure that you’re obeying all applicable laws and creating a legally sound document that will hold up in court.

You’ll also need to draw up a purchase and sale agreement as well as a mortgage or deed of trust (depending on your state).

When all the documents are ready, you can review and sign them. And then you’re done! Except, of course, for all those mortgage payments. But you get the idea.

Recording

In most cases, you’ll want to visit your county recorder’s office after the sale. Recording your sale can help you get relevant tax breaks.

Don’t qualify for a business loan? Get a personal loan instead.

FAQs about owner financing

How does owner financing homes work?

Owner financing homes works pretty much just like owner financing commercial real estate: The buyer and seller have to agree to rates and terms and formalize those financing terms with a promissory note and mortgage. Then the buyer will make payments to the seller, according to their contract.

Is owner financing the same as rent-to-own?

No, owner financing and rent-to-own are two different things.

Rent-to-own gives a renter the option to buy the property at some point, often by getting a conventional bank loan. But if the renter doesn’t want to buy the property, they have no obligation to do so.

With owner financing, the buyer actually owns the home as they make payments to the seller/former owner. There’s no need to secure more financing at that point, and there’s also no option for backing out.

Is owner financing a good idea?

An owner financing arrangement can be a good idea in certain situations (which we explain in detail above).

If you’re a buyer who can’t get a traditional mortgage, owner financing can make it possible for you to buy property. If you’re a seller who needs to offload a property quickly, owner financing can speed up the process.

Just make sure, in either circumstance, that you understand the risks.

What is a wraparound mortgage?

With a wraparound mortgage, the property seller still has a mortgage on the property being sold. So when they do owner financing, the new seller-financed mortgage “wraps around” the existing mortgage, usually with a higher interest.

The buyer makes payments to the seller as usual, and the seller continues to make mortgage loan payments on their original mortgage. Any leftover cash is profit for the seller.

The takeaway

An owner financing contract can be a good way for buyers to get a mortgage loan even when they don’t qualify for third-party financing. And for sellers, the speed and potential for extra cash can make the risks of owner financing worthwhile.

All the same, think carefully before you agree to owner financing. There’s a reason most people get funding from commercial lenders, after all. And if you decide to proceed, consult an attorney to keep everything on the up-and-up.

Compare the cost of owner financing with the cost of traditional financing with our commercial loan calculator.

Disclaimer

At Business.org, our research is meant to offer general product and service recommendations. We don’t guarantee that our suggestions will work best for each individual or business, so consider your unique needs when choosing products and services.