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Is Owner Financing the Way to Go if You Have Bad Credit?

By Gina Pogol
Mortgage Credit Problems Columnist


Jayne Asks: Dear Gina, I have bad credit but want to buy a home fast to get the first time home buyer credit. I found a house that the owner is willing to finance for me. What do I need to watch out for if I take this deal?

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Gina Says:

Dear Jayne,

Owner financing can certainly be cheaper, especially if you have credit problems. However, owner financing isn't exactly foolproof. The landscape is littered with people who make a nice living selling and financing the same properties over and over. Especially if they offer you a lease option, be very careful. many scammers love to prey on people with bad credit because they can get a nice down payment from them, then evict them from the home and keep all their money if they're a couple of days late with a payment.

There are other risks you might take with an owner-financed loan that you wouldn't encounter with loans from bad credit lenders.

The biggest one is that the owner could have a mortgage on the house, and if he or she defaults, the lender forecloses on the loan, You could be evicted--even if you have been making payments on time to the seller. You would lose your down payment and lease option money, your monthly payments, and the house.

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 remains in the seller's hands. Not only would you not be eligible for the home buyer tax credit, but the seller could borrow against the property, creating a lien on YOUR home without your knowledge. A default by the seller to this lender could also result in foreclosure. You never want to enter into a contract with a seller without recording some kind of lien against the property to protect your interest. Never enter into this kind of transaction without the guidance of an experienced real estate attorney.

Another potential problem with owner financing is the lack of effective regulation. Homeowners aren't required to provide the same level of disclosure that licensed mortgage lenders are. You would certainly want to be extremely careful and have a lawyer review the language in the real estate lien. For instance, if you think you have a thirty-year fixed rate loan and the seller writes up a five-year balloon note, you could end up in a fix if you still have bad credit and can't refinance out of the mortgage in five years.

Finally, just because a lender isn't requiring inspections and appraisals doesn't mean you don't need them. A low bad credit home loan rate isn't so great if you overpay for the property by $20,000, the septic system explodes the first year, or your well runs dry. Consider also purchasing a title insurance policy. You won't have a lender looking out for your interests, so you have to be vigilant yourself.

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