What are the risks involved in a owner financed loan?
As creditors place stricter and stricter requirements on borrowers, many more homeowners are embracing the practice of owner financing. In many instances, it is the only way the homeowners are able to sell a property. However, there are some risks to the borrower with an owner financed loan that aren't existent with a bank financed loan.
The main risk with an owner financed loan is that the owner could have a mortgage on the house, and could potentially default on their mortgage, resulting in his lender foreclosing on YOUR home, even though you have been making timely payments to the seller. If that happened, you would lose your down payment, and have to surrender the house to the lender, as the lender would become the owner of the property.
Even if the homeowner owns the property free and clear when you purchase the home from them, if the sale is a "contract for deed" or "lease to own" the deed will remain in the seller's hands. The seller can then go out and borrow money against the value of the home, creating a lien on the home without your knowledge. A default by the homeowner to this new creditor could also result in foreclosure.
This is happening frequently. While the following situation involves a lease agreement instead of a purchase agreement, the principle is still applicable. I just had a young mother in my office that had been renting a house for about 3 months. The owner of the home she was renting defaulted on the note, so the bank began foreclosure proceedings. The tenant then received a notice to vacate from the bank. She called the homeowner, and the homeowner explained that he could no longer afford the house even though the tenant had been paying her rent. The homeowner told the tenant he wasn't even able to refund her security deposit. Clearly, she can take him to court, and get a judgement against the owner for her deposit, but that doesn't change the fact that she is going to have to move, and find a new place to live for her family.
Another potential problem with owner financing is the lack of regulation. Homeowners aren't bound to the same disclosure requirements that are required of the traditional lending industry. You would certainly want to be very careful concerning the language in the real estate lien note, and have it reviewed by an attorney. For instance, you don't want a 5 year balloon on the note whereby all payments would become due. You also want an interest rate that is fair and accurately represents the level of risk the seller is taking to finance the home for you.
Owner financing can a good way to connsummate a transaction, but make sure you or your attorney have a thorough understanding of the terms, because the regulatory agencies aren't going to be looking out for you.