Owner financing is when a real estate owner has enough equity to loan all or part of the money for a buyer’s purchase of their real estate. Carrying the financing on a home can be an attractive investment for a seller. It can also be helpful to close the deal faster if banks and lenders will not offer the entire amount of financing necessary, or the home buyer has trouble qualifying for a traditional mortgage or needs more flexibility with a down payment or other financing terms. Owner financing is usually pretty safe since the owner knows the property and the investment is secured by a note and deed of trust. On top of that, the return on the investment can typically be more than what might be available in the investment marketplace.
There are two parts of an owner-financed transaction that create the agreement between the borrower and the owner/lender: the note and the deed of trust. The note is a written agreement stating that the debt is acknowledged and there is a promise to repay it. The deed of trust is a written agreement, which allows the owner of the note and deed of trust to foreclose in the event that the buyer defaults on the payments. This second document is almost always recorded publicly in county records.
Over the years, owner financing has changed and evolved dramatically. In the ’70s, standardized Bradford forms were often used by real estate brokers in a real estate transaction. Rather than brokers creating forms or using Bradford forms, the Colorado Real Estate Commission came up with a set of approved notes and deeds of trust for real estate brokers to use. Those forms were used by Colorado Real Estate Brokers through 2013. As a result of Federal legislation commonly known as Dodd-Frank in January 2014, the Colorado Real Estate Commission removed the financing language from the standard Colorado Contract to Buy and Sell. The standard forms for notes and deed of trusts were repealed, and a whole new set of rules followed suit.
Today, there are two common types of owner financing. In the first type of owner financing, a seller owns a property free and clear of any mortgages. This enables the seller to carry a note and a first deed of trust. In this case, the buyer and seller agree to a down payment amount and the terms (length of loan, interest rate, and payment schedule). At closing, title will transfer to the buyer, and the seller’s security is the deed of trust signed by the buyer. In the second type of owner financing, a seller carries a “second” lien on a property. It is called a “second” because the loan will be in second position, or subordinate to a first mortgage from a bank or mortgage company. Just like the first deed of trust, the buyer and seller agree to the down payment amount and the terms of the loan. From the seller’s point of view, there might be more risk because the first deed of trust is in front of the “second” and if the buyer defaults, the seller would need to foreclose and pay off the first mortgage before the second lien. If the buyer is getting a new conventional first mortgage, the buyer always needs to disclose the terms of the “second” to the first lender for qualifying purposes.
Sellers of their personal residence essentially get a free pass to sell their home without having to comply with more complicated owner carry rules. However, it is still a good idea to employ a real estate attorney or licensed mortgage loan originator (MLO), to make sure the documents are prepared correctly, in accordance with both Federal and Colorado law. In Colorado, the law allows up to three owner-financed transactions a year without have to comply with additional rules. In the event a seller has more than three properties and wants to sell them with owner financing in the same year, it is required that a seller use an MLO to process and qualify the transaction. It is possible for sellers of multiple properties to actually become a licensed MLO rather than hiring an independent one.
As always, anyone considering selling their home or buying a home with owner financing should consult the appropriate licensed professionals, such as an attorney, mortgage loan officer, and Realtor® to help them make their decision and structure the transaction.
By Duane Duggan. Duane has been a Realtor for RE/MAX of Boulder in Colorado since 1982 and has facilitated over 2,500 transactions over his career, the vast majority from repeat and referred clients. He has been awarded two of the highest honors bestowed by RE/MAX International: The Lifetime Achievement Award and the Circle of Legends Award. Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life. For questions, e-mail DuaneDuggan@boulderco.com, call 303.441.5611 or visit boulderco.com.