How To Refinance Your Seller-Financed Mortgage

August 16, 2016 - 5 min read

Got Owner Financing? What To Do Now

Many home buyers purchase their home by getting a loan from the seller — not from the bank.

Owner-financing, which is sometimes called “Seller Financing” is common when a buyer does not meet standard mortgage guidelines.

Whether you have unique income circumstances or a challenged credit profile, owner financing is an alternative to getting a traditional loan.

With financing provided by the seller, a buyer can stop renting, and start owning, sooner.

But what happens when the buyer needs to refinance out of the seller financing? A loan from the seller doesn’t always come with the most advantageous terms. And, they are often due in full after a short period of time.

Homeowners who carry seller financing should know a number of strategies to refinance into a traditional loan that comes with more manageable repayment terms.

>Related: The best way to refinance your mortgage

What is a Owner Financing?

Owner financing is an arrangement in which the seller acts as the bank, providing a private mortgage. It is an agreement between buyer and seller for the exchange of real estate ownership.

Instead of the buyer getting a traditional loan through a mortgage company or bank, the buyer finances through the existing owner of the home.

This arrangement is known by a few different names.

  • Owner financing
  • Seller financing
  • Land contract
  • Contract for deed

They all mean the same thing: you’re getting a loan from the current owner of the home.

So is it easy to get owner financing? Not quite. Homes for sale on land contract are not easy to come by. Most sellers want to be paid in full at closing of the sale. This helps the seller pay off their own mortgage.

A home can’t legally be sold on land contract unless it’s owned free and clear, which is another reason why these are hard to find. Most people carry some sort of mortgage on real estate.

Example Buy-Then-Refinance Scenario

The following is an example situation in which a buyer may opt for owner-provided financing.

It has been two-and-a-half years since the buyer had a short sale on his previous home due to job loss.

Since the short sale, he is back with a new employer and saving money in the bank. He is ready to be a homeowner again.

He researches guidelines. But, they don’t allow for a new mortgage until at least 3 years have passed since the short sale, except under FHA Back to Work guidelines, for which he doesn’t quite qualify.

Instead of renting, he finds a home available for sale “on land contract” and makes the purchase.

He comes to an agreement on terms and price of the home with the seller. After successfully recording of the owner-financed sale, and making 12 on time payments, he is now ready to refinance.

The new loan will pay off the seller financing and get him into a loan with more traditional and suitable terms.

Owner Financing Is Not Renting

There is a common misconception that receiving owner financing means that you’re renting the home.

The truth is, when the land contract is recorded, you become the homeowner.

This means you pay the taxes, and you are responsible for maintaining the home.

Owning a home via owner financing also means that you are entitled to any equity in the home when you sell or refinance. If you have adequate equity, a refinance should not require much, if any, out-of-pocket expense.

If the equity exists, there is no need for downpayment when you refinance, because you already own the home.

The Challenge With Owner-Financed Mortgages

Owner-financed land contracts are often structured on a 5-year balloon mortgage. This means they are due in full after just five years, no matter how much or how little the buyer has paid off.

Some come with 10-year amortization, meaning a schedule of payments that completely pay off the loan in 10 years. This option results in very high mortgage payments.

These types of loan structures can really keep a borrower up at night, and create much more financial pressure than a standard 30-year fixed mortgage.

It doesn’t take long for the borrower to realize it’s time to seek refinancing options.

The requirements to refinance a land contract are fairly basic.

  • The land contract must be recorded properly
  • Cash out is not allowed, typically
  • Documentation must prove 12 months of on-time payments
  • The applicant must meet traditional credit and income guidelines

If the land contract is not recorded, the new transaction will be treated as a purchase, not a refinance.

To determine the value of the home the lender will use the original agreed-upon home price or the appraised value, whichever is less. That applies if the land contract was recorded within the most recent 12 months.

If the land contract was recorded more than 12 months ago, the new value can be used. The applicant will need a new appraisal, ordered by the new lender.

Preparing To Refinance The Owner-Financed Loan

When you purchase a home via owner financing, use a local real estate attorney’s office or title company to complete due diligence on the property history.

You want to make sure the owner has the legal right to sell the property, and there are no other owners.

Taking extra steps at purchase will ensure you won’t run into any deed issues or lien discrepancies in the future when you sell or refinance.

A reputable, established title company will record the land contract properly. “Recording” just means that the county or other local authority creates an official record of ownership transfer.

Keep a meticulous record of all land contract payments because the payments are not reported on your credit report.

Also, think about the main reason owner financing was your only option. Was it your credit or income? Or was the property deemed unacceptable by a traditional lender?

After getting into the home, take the next 12 months to fix the income, credit, or property issues that led to the owner financing in the first place. This could make the traditional refinance a smooth and successful process.

Stay in close contact with the land contract holder. They will want to know when the refinance will take place.

Maintaining a good relationship with the previous owner can make a positive difference as you work through the refinance process.

Top 4 Reasons An Owner-Financed Loan Refinance Is Turned Down

Not every homeowner will successfully refinance out of their owner-provided loan. The following are the most common reasons for which lenders turn down these refinance applications.

  1. The loan was not recorded properly or it can’t be located
  2. The lender cannot verify payments on the loan
  3. Questionable previous ownership, or other title issues are discovered
  4. Borrower credit or income does not qualify for traditional financing

When buying a home is more affordable than renting, owner financing can be a sound temporary solution if you do not qualify for traditional financing. Following the aforementioned guidance could lead to a swift approval when it comes time to get into a better loan.

What Are Today’s Rates?

Today’s refinance rates are low, making it the perfect time to retire your high-payment or high-risk owner financing. There are no rate increases or penalties for paying off a non-traditional loan.

Get a rate quote now and get into a low fixed rate with manageable payments. No social security number is required to start, and all quotes come with access to your live credit scores.

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