Can you refinance a seller-financed mortgage?

August 5, 2022 - 8 min read

Do you have owner financing? What to do now

Some home buyers get their mortgage loans from the home’s seller — not from a mortgage lender.

This kind of financing, known as “owner financing” or “seller financing,” can help buyers who don’t meet standard mortgage guidelines at the time of purchase.

But most of the time, owner financing isn’t a permanent financing arrangement. At some point, the borrower will need to refinance into a traditional home loan. If you’re in that situation, here’s what to do.

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>Related: The best way to refinance your mortgage

What is owner financing?

With an owner-financed home, the home seller acts as the bank or mortgage lender. Instead of making monthly payments to a mortgage loan servicer, the home buyer makes payments to the seller. The buyer may also make a down payment to enter the financing agreement.

This kind of financing arrangement goes by a few different names:

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

They all mean the same thing: You’re getting financing from the current owner of the home.

Owner financing is not the same as a lease-purchase agreement. With a lease-purchase, you’d be renting the home with an option to buy it later.

How to refinance an owner-financed mortgage

The requirements to refinance an owner-financed home are fairly basic.

  • The land contract must be recorded properly
  • Cash out is typically not allowed
  • 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 — and you might not benefit from the equity you’ve built.

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 an owner-financed home loan

Preparing to refinance your owner-financed home should begin the day you enter the owner-financing arrangement.

1. Properly record the home sale

When you buy 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 these extra steps at purchase will ensure you don’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.

2. Keep accurate records and build credit

After you’ve closed the deal with the seller, keep a meticulous record of all land contract payments because the payments are not reported on your credit report.

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

3. Communicate with the seller

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.

4. Shop around with traditional lenders

As you approach the end of the first year in your new home, you may be ready to find permanent financing through a refinance loan — especially if you’ve been building your credit.

To find the best deal on a new mortgage, shop around with at least three lenders. Compare mortgage preapprovals. They’ll show a quote that’s customized to your personal finances.

When you compare quotes, make sure you’re comparing the same type of loan with the same loan term.

Refinance loan options for owner-financed homes

If your current mortgage is seller-financed, you still have several good options for a refinance loan:

  • FHA loans: Because they include government mortgage insurance premiums, FHA loans help borrowers with average credit avoid higher interest rates
  • Conventional loans: If you’ve re-built your credit, you may save money with a conventional refinance, especially if you’ve also built up 20% in home equity. That’s enough to avoid private mortgage insurance premiums (PMI)
  • VA loans: Borrowers with current or previous military service can use the VA loan program which offers competitive rates and does not charge mortgage insurance premiums

With any of these loan types, homeowners can choose different loan terms. Shorter repayment terms, like 15- or 20-year mortgages, can save a lot in long-term interest payments compared to a standard 30-year loan.

But shorter terms will also increase monthly payments. Your loan officer can help you find the term and loan type that best fits your specific needs.

Potential issues when refinancing an owner-financed home

Not every owner-financed homeowner will qualify for refinancing. But if you know why these loans get turned down, you can learn how to qualify for one.

The following are the most common reasons for which lenders turn down owner-financed refinance applications:

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

Let’s look at these reasons more carefully:

1. Owner-financed loan recorded improperly

Unless you sign a promissory note, and unless the deed to the home gets recorded in your name, you won’t have the right to refinance the home.

When you finalize your purchase agreement with the owner, make sure the deed is transferred and properly filed with your county government.

2. Lender cannot verify payments

Home sellers who finance the purchase price won’t report your regular payments to credit bureaus. So when it’s time to refinance, your mortgage lender will need another way to verify you’ve made regular, on-time monthly payments on the house for the past year.

Most of the time, your bank statements can show your repayment history. But if you paid cash for some of the payments, this might be more difficult.

3. Questionable previous ownership

Mortgage lenders can’t refinance a home unless it has a clean title. If the home has liens or a disputed ownership history, the lender won’t be able to approve your refinance.

Before you enter your owner-financing arrangement, hire a title company to do a title search, just like you would if closing on a bank-financed loan. Title work will add to your closing costs, but it will also protect the investment you’re making in the home.

4. Borrower doesn’t qualify

One of the biggest advantages of seller financing is the ease of qualifying. First-time home buyers, or others with thin credit files, can qualify.

If you’ve entered an owner-financing agreement because you couldn’t qualify for a traditional loan, be sure to improve your credit score before the loan’s balloon payment comes due.

It’s never too early to start building, or rebuilding, your credit. And since your monthly payments on the owner-financed home won’t be reported to the credit bureaus, your other debt payments — credit card bills, car loans, student loans, or personal loans — will be key.

Making on-time payments, paying down balances, and avoiding unnecessary credit checks should help improve your credit history.

Example of refinancing an owner-financed home

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

Two-and-a-half years ago, the home buyer lost their job and had to “short sale” their previous home.

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

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

Instead of renting, they find a home available for sale “on land contract” and contact the seller.

They reach a purchase agreement with the seller. After successfully recording the owner-financed sale at the county courthouse — and making 12 on-time payments from his bank account — they are now ready to refinance.

The new home loan will pay off the seller financed loan, avoiding the balloon payment they’d be facing in four years. Simultaneously, the new loan lowers their interest rate since owner-financed homes typically have higher mortgage rates.

The challenges of owner-financing arrangements

Most mortgage loans spread your mortgage debt across 30 years, allowing for lower monthly payments. Buyers who can afford higher payments may choose a 15-year term instead.

Owner-financed land contracts are often structured on a five-year balloon mortgage. This means buyers make regular payments for five years. Then, the remaining loan balance becomes due all at once, as a balloon payment.

No matter how much or how little of the purchase price the buyer has paid off, the entire balance comes due all at once.

Balloon payments may be $250,000, $400,000, or more — it all depends on the initial purchase price of the home and the size of the monthly payments you make during those first five years.

Some home purchase agreements come with a 10-year amortization, meaning buyers can completely pay off the loan in 10 years. But this option creates very high mortgage payments.

For example, financing $300,000 over 10 years at 7% interest would require paying about $3,500 a month — and that wouldn’t include taxes or insurance or HOA dues.

Either of these loan structures can keep a borrower up at night, creating more financial pressure than a standard 30-year fixed mortgage.

Who needs an owner-financed mortgage?

An owner-financed home may be your best option if you can’t buy a house with a traditional mortgage loan because of a previous foreclosure or simple bad credit.

This kind of financing may still work because a home seller, unlike a mortgage lender, doesn’t have to follow Fannie Mae and Freddie Mac’s credit score and debt-to-income ratio rules.

If you enter an owner-financing arrangement, think of your loan as temporary — a way to get your foot in the door of homeownership so you can start building equity instead of paying rent while you build your credit.

Within five years, you’ll need a permanent financing solution.

For most home buyers with owner-financed homes, the best permanent solution is a mortgage refinance. The refi converts the loan amount into a conventional mortgage or a government-backed FHA loan. Some borrowers can get VA or USDA loans.

Owner financing is not renting

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

The truth is, when the land contract is properly recorded, you become the homeowner. This means you pay the taxes, and you are responsible for maintaining the home and buying homeowners insurance.

Buying a home via owner financing also means you are entitled to the home’s equity when you sell or refinance.

If the equity exists, there is no need for down payment when you refinance, because you already own the home. If you have at least 20% equity, you can avoid mortgage insurance payments, saving more money each month.

What are today’s rates?

While today’s refinance rates are higher than they were in 2020 and 2021, they may still beat the rate you’re paying on your owner-financed loan. Owner-financed loans normally charge higher-than-average rates.

To find out exactly where you stand with a traditional lender, apply for a mortgage preapproval.