Owner Financing
Mortgage vs. Contract for Deed, Part I
Owner Financing. Because of recent credit tightening, sellers are finding it difficult to find buyers who qualify for conventional financing and are forced to offer owner financing. Alternatively, a seller may want to receive the proceeds from a sale over time to defer taxes and to receive a good return on the money until the owner needs it. Sometimes the buyer puts little or nothing down.
Owner financing can also have fewer closing costs for buyers than conventional financing, since owners commonly do not require origination fees, application costs, title searches and title insurance, appraisals, termite and building inspections, and surveys. This speeds up the transaction. Of course, forgoing many of these costs can result in great risk to the buyer.
The time period of owner financing is often short, followed by a balloon payment. The buyer agrees to this, thinking that satisfactorily making the payments will repair the buyer’s credit in time to refinance the balloon. However, sellers do not report to credit reporting agencies, and the owner financing will have no effect on the buyer’s credit. On the other hand, the owner financing will allow the buyer to build equity before the buyer has to refinance the balloon.
Typically, the buyer becomes responsible for paying taxes and insurance. If the buyer does not pay the taxes and insurance, the seller can put the buyer in default in the same manner as if the buyer did not make his regular payments under the loan.
Mortgage or Deed of Trust. In cases when an owner provides financing to a buyer of real property, the seller typically sells the property to the buyer by way of a deed, and simultaneously the buyer executes a promissory note and mortgage in favor of the seller. The promissory note is a promise to pay money to finance the purchase. The mortgage puts the real property up as collateral to secure the promissory note. The buyer becomes the legal owner of the property, but the seller has a lien on the property.
This is the same as when the buyer obtains conventional financing from a third-party lender. When a deed and mortgage are part of one transaction, the mortgage is known as a purchase money mortgage and takes priority over preexisting judgment liens against the buyer.
If the buyer defaults under the promissory note or mortgage, the seller may accelerate the promissory note, which has the effect of making the entire amount of the promissory note immediately due and payable, and foreclose on the property.
A foreclosure is a legal proceeding through which the property is sold at public sale and the proceeds of the sale are used to pay the costs of the sale and then are applied to the debt secured by the promissory note, then to other secured debt and, if anything is left over, to the debtor.
In Arkansas, creditors may opt for a deed of trust, rather than a mortgage. Practically, the only difference between a mortgage and a deed of trust is in how the property is foreclosed on. A deed of trust contains a power of sale clause, which permits a foreclosure sale without intervention of a judge. There are very stringent notice requirements before the sale can take place. A mortgage, on the other hand, requires a judge to enter a judgment of foreclosure.
In either case, a foreclosure in Arkansas takes approximately 120 days, assuming the borrower does not contest the foreclosure and does not file bankruptcy. There is a one year right of redemption under judicial foreclosure that is typically waived in the mortgage document.
If a mortgage or deed of trust is used with owner financing, it is important that an Arkansas attorney draft the documents to ensure that appropriate language is included in the mortgage or deed of trust and promissory note.