Owner financing of homes comes with risks

It is no secret that lending institutions have been forced to tighten requirements since the financial crisis of 2008. But a little-discussed financing mechanism known as owner financing, or seller financing, is a cause for concern according to a seller and a mortgage originator in the region.

This form of financing has the seller carrying all or a portion of the financing. The buyer and the seller agree on the interest rate, monthly payment amount, insurance obligations and other terms. The agreement is typically noted in public records to protect the parties.

It is something Fort Smith home owner Greg Pair Jr. has been hearing about a lot since he put his home on the market four months ago.

"We've had one offer, but it fell through because of financing. They could not get the financing (to purchase the home)," he said. "We've also had at least four or five calls to see if we could do owner financing because of the inability to get financing at the bank."

Pair and his wife Jamie were not comfortable with selling their home through owner financing.

"Owner financing would mean we would still have the loan on the house. It's essentially the same as a rent-to-own option. It would be paying us the monthly payment to pay off the loan. In turn, it would hurt us because we couldn't carry that loan plus the loan on the new house."

Walt Fenton, a mortgage originator at First Security Bank in Rogers, said Pair's views on owner financing were correct. According to Fenton, term owner or seller financing is not even an accurate depiction of the financial transaction taking place.

"He's doing a contract for deed where the contract remains in his name," Fenton said. "Owner financing is really where they own the property free and clear and the buyer puts down 20%. We'd count that whole mortgage against him unless he can prove that he's been receiving the payments for at least 12 months."

The risks associated with doing owner financing are many, Fenton said, adding that anyone who is asked to do owner financing, as Pair has been, should think long and hard about why they would need an alternative financing solution.

"If they're having trouble with their credit, why would I want to carry a note on them," he asked. "If they are a poor credit risk to a bank, why would the seller want to take that risk?"

While signs have been popping up across the Fort Smith region with messages about owner financing and more people have started talking about it, Long and Fenton say it is still rare in the Northwest Arkansas regions. Long, who said he has not yet sold a home through owner financing, said in his opinion, it would likely only be a good option for certain types of properties.

"Owner financing, I think, would be more (suitable) for mobiles (mobile homes) which are hard to finance or specific properties that are hard to finance for whatever reason. And I've heard of lease-to-buy, that's sort of owner financing. But I just don't know. I just haven't run across it much."

Fenton said all individuals who may be in the market for a home at any point in the near future need to get used to the more difficult lending procedures and be prepared for the rare, but still possible, rejection for a loan.

"We're back to the old days where their debt to income ratios should not be more than 28% of monthly income. We don't want that other debt to exceed 41% unless there are great compensating factors – high credit scores, long term job security," he said. "You need money, you need a job, you need good credit. It's back to the good old days."

Should a prospective buyer be denied, Fenton said it is not the end of the world and they don't necessarily have to resort to alternative financing options.

"We do see some people with poor credit and we do some counseling with them. They may have to come back in six months, a year or two years. But in the grand scheme of things, two years goes by relatively quickly."

If a seller does choose to extend financing themselves to a buyer, Century 21 advises that the seller take measures to fully protect themselves.

"You should run a full credit check on the borrower, require hazard insurance on the property and include a due-on-sale clause. There also are financing, disclosure and repayment-term requirements that need to be met. Again, it is wise to consult an attorney when considering this type of transaction."

As for Pair, he is hoping his home sells quickly through traditional financing so he and his family can purchase their next home.

"The bad part for us is we wouldn't be able to purchase the other house, we couldn't officially go through on the house. We're (in a contract to purchase our next home) contingent on selling our (current) house. We need the equity in our house to pay the down payment on the new house."