Buyer’s Risks with Owner Financing
Buyers of owner financed property are exposed to risks which are normally filtered out by the closing requirements of conventional financing.
1. Many owner financed deals are closed without title insurance. There may be problems with the sellers title that will cause problems in the future. For example, I know a guy who lease/options homes and then sells them on contract. If there are problems with his leases he will find it difficult to actually transfer title when the time comes.
2. In their eagerness to get a home of their own buyers may agree to larger payments, higher interest rates, or short balloons. If times get tough, someone looses their job for a few months, or an unexpected baby arrives, they may not be able to continue buying their house. Some sellers actually count on getting the house back this way, keeping any downpayments, and selling it again.
3. The buyer must be sure to get copies of and read carefully all the sellers mortage paperwork. For example, the seller expects to use the buyers payment to pay the existing mortage. That is fine, but what if the sellers mortgage is an adjustable rate loan and the payment increases a lot? If the seller financing did not make provision for this situation the seller may find himself making a payment which is larger than the buyers. If the seller can’t or won’t do that, the buyer has a problem.
4. Since the seller is frequently still responsible for payments on underlying loans, it is possible for seller problems to spill onto the buyer. A messy divorce, tax problems etc. can all do this.
{ 10 comments… read them below or add one }
What happens if the seller doesn’t apply the money to their loan on the property?
I would hope you are closing the transaction at a title company or using a lawyers escrow account to handle the money at closing. For monthly payments I would expect to make payments to an escrow company that pays the underlying and sends the balance, if any, to the seller.
Paying the seller directly would be a really bad idea.
I am buying a trailer and land from an owner that does not have a lien on it. I am just wondering what kind of paperwork is needed. We have signed and date agreements including interest rates and payment schedule. Is this enough? Nothing is notorized.
How do you know it doesn’t have a lien on it? Even if the seller is truthful and believes there is no lien, he may or may not be correct. People do funny things when someone dies, is divorced etc. They backdate documents, sign other people’s name, etc. “Grandma meant to give this to cousin Sue, so we will just fill out a deed.” Lots of times it all all works out in the end, but not always. Someone needs to examine the recorded documents at the courthouse to make sure there are no problems.
Related to that is the question of whether the seller is the one and only one who has to sign the sales documents. I live in a community property state (New Mexico). Unless I have gone to great pains to maintain a “Sole and separate estate” I had best have my wife’s signature on the documents.
Finally, the documents need to be notarized before they can be recorded. Recording means you take the documents down to the county clerks office in the country where the property is located, pay a fee, and they take the documents, copy them and the copies go into the public record. In the future anyone who wants to know who owns the property or has any kind of interest in it will be able to find that information in the public record. Recording is what prevents the property from being sold a second time, etc.
I appreciate this adds complexity and cost to what seems like a simple agreement between you and the seller. In fact, the seller may not be willing to go along with it. I just have heard several painful stories of what can happen years later when it turns out there are problems and the paperwork isn’t there to support your position. A lawyer may seem expensive now, but I can assure you it is MUCH cheaper to set things up properly than it is to fix them later!
Thanks for writing and good luck with your deal.
Paul
I have been in a owner finance home for two and a half years. Have an all inclusive trust deed. The note have been paying the mortgage to chase with my name on payment paperwork.I am paying with check always early, and add on every payment more for principle.When I purchased the home,payments were behind along with impound account and taxes. all of these I caught up on. The house is a little upside down.Is there any amount of time that passes when a lender takes someones money,other than the person on the loan,that would enable me to go to the lender and assume the loan?
Not to my knowledge. In fact, the banks are so messed up these days with all default and paperwork issues I would be afraid to do anything that might call their attention to your particular mortgage. In your situation I would wait until I was sure I could refinance before having any contact with them.
Hi,
I am considering purchasing a duplex. It’s a great property and I don’t want to miss out on the opportunity. I am unable to get financing at the moment, but after a couple more months my situtaion will seem a bit more promising for lenders. The seller currently has a mortgage on the property. We would be placing 20% down and making his mortgage payments through escrow with the title being in my name. The term of our agreement is 3 years. Does this seem like a legitimate way to aquire the property or will be get in trouble with his mortgage company and have the risk of the loosing the home?
I would not sign a purchase agreement as the buyer with the terms and situation you describe.
Given the current economic conditions I would not feel certain conventional financing would be available within the time constraints you are talking about. My understanding is that most lenders are in such trouble with bad loans these day they are unlikely to have time to worry about who is making payments on a loan that is current. However, do you and the seller understand he could get a nasty letter demanding immediate payment of the outstanding balance at any time, and that his credit would get trashed if he couldn’t/wouldn’t pay?
Have you quantified the exact benefits of this “opportunity”? Will it cash flow after repairs and maintenance, etc. Will the income hold up if rents have to be lowered? That sort of thing.
What if you arranged a master lease with the right to sub-lease. The “seller” would still be the owner of record. You wouldn’t get the depreciation deduction. What if your 20% was called a refundable/nonrefundable option fee? With the help of an experienced real estate attorney I think you and the seller could come up with agreements that minimized the dangers and still give you each what you are looking for.
I have made an offer to purchase the property I am now renting.
I have asked to owner to finance the loan for 10 years.
What should I put in the contract to protect myself and what can I do to make sure there is not a loan on the property now and to make sure the owners do not get a loan after we sign our contract.
You should sit down with an attorney. They will have more or less standard documents with language that protects both buyer and seller in this kind of deal. The document will include things like what constitutes default, requirements and time periods for notification and cure of default, keeping the property insured, paying taxes, and lots of other stuff to numerous to list.
Where I live (NM) you would get a title insurance policy. The title company searches the public records to see if there are outstanding loans or other issues that would prevent the seller from being able to deliver good title to you. I understand that in some/many of the eastern states a lawyers title opinion is used to do much the same thing.