The Difference Between Owner Financing versus Traditional Financing

Owner Financing

Owner financing, often called seller financing, means that a buyer will be making payments to the seller rather than taking out a mortgage loan to pay for the house. Owner financing is rare because the sellers would rather get a lump sum payment as opposed to taking their equity over time. Before you sign an owner financed contract, have a lawyer look over the paperwork and make sure you know your money’s being used properly if the owner still needs to make underlying payments on the house.

Pros

If an owner is willing to finance you, you will not have to qualify for a mortgage loan. This is especially good for those who can’t qualify for a bank loan. Also, because you are negotiating with a person rather than a bank or company, you have a better chance of extending payment periods or decreasing monthly payments. For the owner, this type of financing allows him the leverage of raising interest rates due to the attractiveness of the buyer avoiding a bank loan, and interest rates are pure profit for the owner.

Cons

The major risk the owner endures when owner financing is whether or not the buyer can make his monthly payments. This is only a minor setback if the owner has spent time drawing up detailed paperwork with the professional approval of a lawyer or real estate broker, because if the buyer cannot make payments then the seller can foreclose on the house, taking it back as payment. However the owner must be able to enforce her stance with paperwork, and if it’s unclear then she may be at risk of legal action. Another potential problem for the seller is that they will typically not receive all of their equity in an upfront payment, but will instead receive a long series of small payments. A consequence for the buyer is that often interest rates are higher on owner financed houses than on traditionally financed houses.

Traditional Financing

Traditional financing to buy a home means that a buyer qualifies and obtains a bank loan, called a mortgage, to buy the house and then spends between 15 and 30 years making monthly payments to the bank to pay off the mortgage and interest. Often the buyer must make a down payment on the sale price, paying between 3 and 20 percent. The larger the down payment, the smaller the interest rate and monthly payments and the easier it will be to qualify for the loan. You can qualify for a mortgage if you’ve had steady employment for at least 2 years, decent credit, an income that supports the purchase of the house and the ability to make a down payment.

Pros

One benefit of purchasing a home through a bank loan rather than an owner is that you have the security of professional paperwork. You can read through your contract and know what you’re bound to without the concern of potentially dealing with an unprofessional seller or a scammer. Also, for buyers, the interest rate is often smaller when using traditional financing than when owner financing. The benefits for sellers are that they know the buyer has a steady job, can afford the home and has decent credit, and they get the payment for the house upfront.

Cons

A major issue with traditional financing for the buyer is that he may not qualify for a mortgage. It’s easy not to qualify for a bank loan if you’ve been moving between jobs, cannot afford a down payment on the house, or have bad credit. Traditional financing gives no leeway for buying a home to those unqualified. In this sense, a con for the seller is that the pool of potential buyers shrinks to those who qualify for a mortgage, even though other potential buyers might be able to afford the house. This means it takes longer to find a buyer and seal the deal, and the seller may have to drop the price of the house significantly.