Texas Owner-Financing: Legal Strategies and Risks (2024)

Owner-financing, also known as seller financing, is a method of financing a property purchase where the seller provides the financing to the buyer rather than a traditional mortgage lender. In Texas, owner-financing can be a viable option for buyers who struggle to obtain conventional financing. However, this method of financing carries unique legal strategies and risks that both buyers and sellers need to understand. In this article, JC Brooks, J.D., a Texas Generational Wealth and Real Estate Attorney, discusses the legal aspects of Texas owner-financing, offering guidance to buyers and sellers in navigating the legal landscape.

In Texas, owner financing is regulated by several laws, including the Texas Property Code, the Texas Finance Code, and federal regulations, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act. To comply with these regulations, sellers must follow specific guidelines when offering owner financing.

I. Legal Strategies for Owner-Financing Transactions

1. Drafting a thorough and legally enforceable contract: A well-drafted contract is essential in owner-financing transactions. It is crucial for both parties to have a clear understanding of their respective rights and obligations. The contract should outline the agreed-upon terms such as the purchase price, interest rate, term length, and payment schedule. It should also include clauses addressing default, remedies, and other contingencies. Sellers should use a promissory note and a deed of trust to secure owner-financed transactions. The promissory note contains the terms of the loan, including interest rate, payment schedule, and consequences for default. The deed of trust acts as collateral, securing the seller's interest in the property in case of buyer default.
2. Compliance with Dodd-Frank and SAFE Act regulations: Under the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Secure and Fair Enforcement for Mortgage Licensing (SAFE) Act, sellers offering owner-financing must comply with specific regulations. These may include obtaining a mortgage loan originator (MLO) license, providing specific disclosures, and adhering to limitations on the number of properties that can be owner-financed in a 12-month period. It is crucial for sellers to ensure compliance with these regulations to avoid potential legal issues.
3. Utilizing Wraparound mortgages: A wraparound mortgage is a financing technique where the seller retains their existing mortgage and "wraps" the new mortgage around it. This arrangement allows the buyer to make payments to the seller, who then uses those funds to pay the existing mortgage. This strategy can provide significant benefits, including a higher interest rate for the seller, but also comes with increased risks, such as the original lender calling the loan due or accelerating the loan.
4. Utilizing title company and escrow services: Engaging a title company and utilizing escrow services can provide both parties with additional security and assurance. Title companies can ensure a clear title and provide title insurance to protect both the buyer and seller. Escrow services can help facilitate the transaction, hold earnest money, and disburse funds at closing.
5. Recording the transaction: To protect the buyer's interest in the property, it is essential to record the deed and any other necessary documents, such as a deed of trust, with the appropriate county clerk's office. This helps ensure that the buyer's ownership interest in the property is publicly acknowledged and protected.

II. Risks Associated with Owner-Financing

1. Seller's risk of Buyer default: One of the primary risks in owner-financing transactions is the possibility of the buyer defaulting on their loan obligations. In the event of a default, the seller will need to initiate foreclosure proceedings to recover the property, which can be time-consuming and costly. To mitigate this risk, sellers should carefully screen potential buyers, assessing their creditworthiness and financial stability.
2. Buyer's risk of Seller default: In the event that the seller defaults on their existing mortgage, the property may be subject to foreclosure by the seller's lender. To mitigate this risk, request and review a copy of the seller's mortgage agreement to ensure that they are permitted to engage in owner-financing and that the property will not be at risk in the event of seller default. A buyer could also request to be provided copies of mortgage statements from the seller to ensure that any mortgage payments are being paid timely and are current.
3. Buyer's risk of undisclosed liens or encumbrances: Buyers in owner-financed transactions may be at risk of purchasing a property with undisclosed liens or encumbrances. It is crucial for buyers to perform due diligence, including a thorough title search and obtaining title insurance to protect against potential title defects.
4. Balloon payments: Owner-financed loans often come with balloon payments, which require the buyer to pay off the remaining loan balance in a lump sum at the end of a specified term. This can create a financial burden for the buyer, potentially leading to default and foreclosure. Buyers should carefully consider the implications of a balloon payment and explore options to refinance the loan before the balloon payment is due.
5. Due-on-Sale Clauses: Many traditional mortgage loans include a due-on-sale clause, which requires the borrower to pay off the loan in full upon transferring the property. If the seller's original loan has a due-on-sale clause, owner financing through a wraparound mortgage could trigger the clause and potentially lead to foreclosure by the original lender.
6. Legal Disputes: Disputes may arise over property boundaries, easem*nts, or other property-related issues. Engage a real estate attorney to help address these concerns and protect your interests.
7. Predatory Lending: Be cautious of predatory lending practices, such as excessively high interest rates, hidden fees, or unfavorable loan terms. These practices may put a buyer at a financial disadvantage and, in some cases, may be illegal.

Owner-financing can provide unique opportunities for both buyers and sellers in Texas real estate transactions. However, navigating the legal aspects of owner-financing can be complex. Engaging a knowledgeable real estate attorney, such as can help parties involved in owner-financing transactions in Texas.