Financing (part 3) - Owner Financing

Knowledge of owner financing techniques is what separates professional real estate investors from the speculators who, while they could (emphasis on could in the 2008 mortgage market) qualify for traditional mortgages really don’t know much about the real estate investment game beyond the commonplace.

Owner financing is the original form of creative financing. Historically, owner financing was actually more common than financing through institutions, and its important to note that. It’s only over the last 3 or 4 decades that conventional financing has usurped the use of owner financing and I have full confidence that owner financing will come back into vogue more now that the mortgage world is in tumoil.

What do we mean by owner financing? Well, perhaps a corollary example would help you understand the principles. Let’s say you find a classic car for sale for $10,000. The owner owns it outright and you want to buy it. But, you don’t have $10,000. So, you make an offer to the owner to pay $800 a month for 14 months. That totals $11,200 - $10,000 for the car and $1,200 as “interest” for the privilege of paying over time.

This is a simplistic example, and requires that the owner’s car loan be paid off for it to work effectively. As well, the seller will more than likely requiring some kind of security instrument that states he has the right to repossess the car if you don’t complete payment. But, as simplistic as it is, it shows how the process works.

Now, on to a property purchase. The principle works the same way. Let’s say you have found a seller of a property you want to buy. She owns it free and clear and is selling it for $70,000. Rather than pay her $70,000 in cash, or get a loan from a bank for $70,000 you suggest paying her $542 a month for twenty years at 7% interest.

She would get a good return (7% in this case), secured by something she knows and understands – her property. If you default on the loan, she can foreclose and take the property back.

How can this benefit you as an investor? You can acquire a property without the cost, qualification, and scrutiny of a conventional loan. You can get a below market rate while at the same time providing a better than market return to the seller.

What’s more important is that, in a tough credit market like we have now, where investor mortgages are like pulling wisdom teeth to get, you can finance a transaction. That means you get to buy and the seller gets to sell – which is what keeps deals flowing. Moreover, there’s a degree of likelihood that you won’t even need to qualify for the financing because it’s a function of whether the seller has faith in you or not – and, they probably wouldn’t know how to qualify you efficiently anyway.

So, you have a wonderful potential package of benefits – financing when you couldn’t get it otherwise, a good rate, and little to no qualification issues. At the same time, the seller gets the property sold, and gets a good return on the equity the economy has given her through her property. It’s a good case of the win-win.