A small percentage of home sellers might opt for owner financing, essentially acting as lender to a homebuyer. Rather than borrowing from a traditional bank to buy a home, the homebuyer promises to repay the seller for the balance of the home's sale price. This type of sale and financing arrangement is also known as seller carry back or seller financing. It involves a land or sales contract, a promissory note and a deed_,_ to set up.
Setting Sale Terms With A Contract
Owner financing can be structured a few different ways. The choice usually depends on whether the seller agrees to finance, or "carry back," most or just a minor portion of the sale price. For example, a buyer can make a down payment and finance the balance of the sale price with the seller. Or the buyer can obtain a first mortgage to cover a percentage of the sale price -- such as 80 percent -- make a down payment, and finance the remainder with the seller, through a second or junior mortgage.
If the seller finances the entire sale price less the buyer's down payment, the agreement may be written as a land contract, also known as a:
- Land-sale contract
- Installment sales contract
- Contract of sale
- Contract for deed
This document allows the buyer to gain equitable title to the home, rather than full legal title. Legal title and ownership is granted only upon full repayment of the loan which covered the majority of the sale price.
If the seller finances only a second mortgage on the house, a sales contract is usually used. The sales contract works similar to that of an outright sale where no seller financing is involved. The buyer obtains title to the property and becomes the new owner, but has to repay two promissory notes: One to a bank and one to the seller.
A buyer who defaults on a land contract is subject to forefeiture, losing money already paid, and the property, to the seller. A buyer who defaults on owner financing in a sales contract is subject to foreclosure by the seller. Both involve a legal process and court filings.
The Promise to Repay
A promissory note is a legally binding financial document that stipulates loan repayment terms such as:
- Loan amount, which is the initial balance owed
- Interest rate
- Fixed- or adjustable-rate terms
- Late payment penalties
- Repayment term, or number of years or months to pay off the loan
This IOU document does not need to be recorded with the county.
Mortgage or Deed of Trust
Depending on the state, a mortgage or deed of trust is used to secure loan repayment. These documents are known as security instruments, as they tie loan payoff to home ownership. Should the buyer fail to repay the seller in a sales contract, the buyer may lose ownership via the foreclosure process. When the loan is repaid in full, the mortgage or deed of trust is released. These documents are recorded with the county shortly after signing.
Resources and Services
Sellers can open an escrow account with a title company to hold buyer payments, including the deposit, down payment and monthly installments. Sellers can also use a loan servicing company to draft and administer the loan agreement. A loan servicer bills and collects monthly payment on behalf of the seller. Sellers and buyers should each hire a real estate attorney for advice and to prepare the contract, note and deed. Attorneys provide legal guidance throughout the repayment term, and process necessary legal documents should the transaction go awry.