Advantages and Drawbacks of the Top 5 Farm and Land Financing Options
Did you know that more than 80% of Americans have used financing to purchase their properties in 2023? This is a follow up post to How to Finance Buying Land for a Farm. This post explores the advantages and disadvantages of the five most common methods used by contemporary homeowners and landowners to secure or buy land.
Previously, I discussed how paying in cash is often seen as the “best” way to buy property. Why do I think that? Basing on my experience as a real estate agent and investor, I’ve learned key things about cash transactions. I know that paying with cash makes the buying process smoother and thus more appealing. It avoids the extra steps needed to satisfy lenders and speeds up the closing. Let’s say you’re looking at a house to fix up. It might need a lot of work to pass inspections or to match appraisal values. With cash, these are personal factors for you to consider. Is it worth it your time and money to invest in. However, repairs and other living condition factors that are vital considerations for financing with banks or mortgage brokers.
Of course, not doing thorough research on a property could lead to problems. If you’re an investor, you might have a plan for handling known and possible issues. On the other hand, if you are looking for a turn key home, exercise your rights for inspections outlined in a well put together legal purchase agreement to your benefit. You can choose to get an inspection and go through the appraisal process if needed. Everyone can do this, but as a cash buyer, you can choose to skip them.
1. PURCHASING WITH CASH
Cash may not technically be one of the types of “financing,” however, it is a very powerful avenue to purchase property anywhere in the world today. Cash is a potent asset that many individuals lack in today’s world. Frequently, when people discuss “affording monthly payments,” they overlook the true value of cash, viewing it merely as paper. Nevertheless, I’m here to debunk that notion. Cash holds significant power, especially when it’s easily accessible.
You can leverage cash to engage in real estate transactions, house flipping, and alter your financial circumstances in diverse ways. I referenced HELOCs, secondary mortgages, and personal loans as resembling cash because you can employ them comparably. These funds are then deposited into your account, allowing you to utilize them much like physical cash. In contrast, primary mortgage loans or land loans are processed through the title company, and you never physically possess the cash.
Below are a list of pros and cons of making a property purchase with cash:
Pros
- Speed: Cash transactions tend to close more quickly as they don’t involve the time-consuming processes of loan approvals and underwriting.
- Simplicity: Without the need for mortgage applications, credit checks, and complex documentation, cash transactions are simpler and involve fewer parties.
- Negotiation Power: Sellers often prefer cash offers due to their reliability and faster closing times, which can give cash buyers an advantage in negotiation.
- No Interest: Cash buyers avoid paying interest on a mortgage, leading to long-term cost savings.
- No Mortgage Fees: Closing costs associated with obtaining a mortgage, such as origination fees and points, are eliminated for cash buyers.
- No Appraisal Worries: Cash transactions typically don’t require property appraisals, avoiding any potential complications arising from appraisal values.
- No Loan-Approval Risk: Cash buyers don’t face the risk of loan denial or delays due to the lender’s requirements.
- Seller’s Confidence: Sellers appreciate the certainty of a cash deal, which can strengthen your offer’s appeal in competitive markets.
- Easier Property Selection: With no lender restrictions, cash buyers have more flexibility in choosing properties that may require renovation or unconventional features.
- Lower Closing Costs: Cash transactions often have lower overall closing costs compared to financed deals, resulting in more savings for the buyer.
- No Monthly Payments: Cash buyers don’t have to worry about monthly mortgage payments, providing greater financial freedom.
- Potential Discounts: Sellers might be willing to offer discounts or negotiate on the selling price to close a deal more quickly with a cash buyer.
- Reduced Risk of Deal Falling Through: Cash transactions are less likely to fall through due to financing issues, providing more security for both parties.
- Investment Opportunities: Cash buyers can seize investment opportunities quickly, as they don’t need to wait for loan approval.
Cons
- Tied-Up Capital: Using a large sum of cash for a real estate purchase ties up funds that could be invested elsewhere.
- Limited Liquidity: Using cash can reduce your liquidity, making it harder to access funds for unexpected expenses or other investments.
- Opportunity Cost: The money used for a cash purchase can instead be used for other investments with potentially higher returns.
- Missed Credit Building: Financing a property could help you build a positive credit history, which might be beneficial for future financial transactions.
- Difficulty in Competitive Markets: In highly competitive markets, cash offers might not have the same advantage if other buyers are offering higher prices with financing.
- Potential for Overpaying: Without the scrutiny of a mortgage appraisal, there’s a possibility of overpaying for a property.
2. FINANCING WITH THE BANK
As mentioned earlier, a considerable majority, approximately 80%, of property owners do not possess the financial means to make substantial purchases, such as real estate, outright. Most commonly, individuals turn to banks for financing, making bank financing the predominant types of financing in the United States today. It serves as a significant milestone on the journey to becoming a homeowner and stands out as the most widespread among the five types of financing. Now, let’s delve into the pros and cons of purchasing property using bank financing.
Pros
- Access to Larger Purchases: Bank financing allows for larger purchases, without needing a substantial amount of cash upfront.
- Amortized Payments: Allows to spread the cost over time through regular mortgage payments, making it more manageable for your budget.
- Potential Tax Benefits: Mortgage interest payments may be tax-deductible, providing potential tax benefits that could help offset your financial burden.
- Investment Opportunities: Instead of tying up a significant amount of your cash in a single property, bank financing allows you to use your available funds for other investments and opportunities.
- Building Credit: Successfully managing a mortgage can contribute positively to your credit score, opening doors to favorable interest rates and financial opportunities in the future.
- Flexible Repayment Terms: Banks offer a variety of mortgage options, allowing you to choose terms that align with your financial goals and circumstances.
- Capital Preservation: By not tying up all your cash in a single purchase, you can preserve capital for other needs and emergencies.
- Ownership Benefits: You can enjoy the benefits of property ownership while gradually paying off the loan, giving you a sense of stability and investment in the property.
Cons
- Speed: Bank-financed transactions tend to take longer to close due to the loan application period, loan processing, and underwriting. Additionally, time is needed to order, complete, receive, and review appraisals.
- Complexity: Depending on your financial situation, especially if you have businesses, are self-employed, or have a complex work history, mortgage applications can be challenging to complete.
- Negotiation Power: Typically, when going through financing, negotiation power on price is lower. Sellers can impose restrictions on the financing terms they are willing to accept.
- Interest Payments: If you are putting less than 20% cash down on a loan, you will most likely have to pay PMI (property mortgage insurance). In addition to the current interest rate of your loan.
- Mortgage Fees: Closing costs associated with obtaining a mortgage, such as origination fees and points, are significant expenses for non-cash buyers. These costs are usually rolled into the loan but may still affect your monthly mortgage payment.
- Appraisal Concerns: All bank and mortgage lenders require property appraisals. This is to ensure that the loan they are granting has enough collateral in case of loan default. Some properties may not appraise for the purchase/loan price you are offering. The lender is looking out for both you and themselves.
- Loan Approval Risk: Sometimes people haven’t applied for a loan yet when they put an offer down. This can prove to be a risk for the buyers and may lead them to default if they do not obtain loan approval within the specified timeframe mentioned in their purchase and sale agreement.
3. FINANCING THROUGH OWNER CARRY/ OWNER FINANCE
Our Experience
One of our most successful investment opportunities came from this type of financing. Owner carry options offer valuable opportunities, especially when sellers fully own the property. We’ve personally engaged in two owner carry finance transactions to acquire properties. Our decision was driven by a desire to avoid the complexities of traditional bank processes. With limited funds for a significant down payment, securing bank approval for a renovation project was challenging.
Our initial purchase was a modest cinderblock single-family home that needed extensive repairs. We managed to put down around 7% in cash, though it was quite a stretch for us. Despite this, we saw potential in taking on renovations while residing there. This was in the early days of our marriage and without kids, allowing us to put in hard work and rent it out as we considered further options.
Later that year, fate led us to a charming home being sold by an elderly couple. It was conveniently located in town and close to our workplaces. Considering our recent purchase of our first home, securing a bank loan for this property would have posed a challenge due to elevated debt-to-income ratios. After discussions, they were open to another owner finance arrangement.
Both of our owner carry agreements were structured around a 30-year amortization rate, accompanied by a 5-year balloon payment. This arrangement required us to pursue refinancing through a financial institution within that designated timeframe.
Posed Concerns
Did this pose a concern for us? While it might have been a potential concern, we held firm confidence in our capability to accumulate equity and carry out property renovations within that specified duration. The added advantage of not being bound by bank-mandated down payments provided an additional layer of reassurance in adopting this strategy. Always be sure to perform contracts through title companies. This is the safest for you as the buyer, and offers protection to the seller as well.
Pros
- Refinance option: My personal favorite feature is when you refinance through a bank, they typically don’t demand a down payment.
- Flexible Terms: Owner financing lets you work out loan terms directly with the seller, possibly leading to better conditions for you.
- Quick Transactions: Deals with owner financing can often happen faster than bank loans because there’s less banking paperwork and processing.
- Wider Property Range: Sellers offering owner carry options might be open to selling unique properties that banks may not finance.
- Lower Closing Costs: Owner financing deals have fewer closing costs compared to bank loans. The fees are usually title fees that may include long term escrow fees.
- Interest Bargaining: You can discuss the interest rate with the seller directly, potentially getting better borrowing terms.
- Lower Down Payment: Owners might offer more flexible down payment options.
Cons
- Interest Rates: The interest rates that are offered tend to be higher compared to conventional bank rates
- Equity Risks: Until the property is fully paid off, the seller retains an interest in the property. If you fail to fulfill your payment obligations, you risk losing the property and the equity you’ve built. Look into having an attorney build your contract.
- Balloon Payments: Most often contracts include balloon payments, requiring a significant lump sum at a specified point in the future. Failing to secure funds for the balloon payment can lead to complications.
- Limited Options: Not all sellers are willing or able to offer owner financing, potentially limiting your choices when searching for a property.
- Lack of Legal Protections: Bank loans come with legal safeguards and regulations, while owner financing may lack similar protections, leaving buyers vulnerable to potential disputes or unfair terms.
- Seller’s Financial Situation: If the seller’s financial situation changes during the financing period, it could impact your agreement, potentially causing disruptions or complications.
4. FINANCING THROUGH A LEASE-TO-OWN
Our second property, acquired through owner financing, originally began as a lease-to-own arrangement facilitated by the title company. Our payment structure involved a 40/60 split: 40% allocated to the loan’s principal and 60% designated as rent. As we accumulated funds for a down payment, we collaborated with the seller and the title company to transition into a complete owner carry setup, with an interest rate that we both parties found agreeable.
Pros
- Path to Homeownership: Provide an opportunity for individuals with limited credit or down payment funds to work towards homeownership while renting the property.
- Lock-in Purchase Price: The purchase price is often agreed upon upfront, allowing you to lock in the property’s price even if its value increases during the lease period.
- Equity Building: A portion of your monthly payment goes towards building equity in the property, helping you accumulate ownership over time.
- Test Ownership: Living in the property before committing to a purchase lets you experience the home and neighborhood, helping you determine if it’s the right fit.
- Less Stringent Qualifications: May have less strict qualification requirements compared to traditional mortgages, giving you a chance to prove your financial stability.
- Time to Save: Can provide additional time to save for a down payment and address financial challenges before finalizing the purchase.
- Flexible Terms: You might have room to negotiate terms directly with the seller, potentially leading to more favorable conditions for both parties.
- Investment Opportunity: If the property’s value appreciates during the lease period, you could potentially gain from the increased value when purchasing.
Cons
- Financial Uncertainty: May not guarantee that you’ll ultimately buy the property. If circumstances change, you could potentially lose the equity and funds you’ve invested.
- Higher Overall Cost: Often involve higher monthly payments, which can include both rent and an additional amount going towards the future purchase. This can result in a higher overall cost compared to a straightforward purchase.
- Limited Control: While you’re living in the property, the seller still owns it, which means you might have limited control over certain aspects like renovations or major repairs.
- Property Condition: If the property’s condition deteriorates during the lease period, you might face the challenge of deciding whether to continue with the purchase or walk away.
- Contract Complexity: Lease-to-own agreements can be legally complex, involving detailed contracts and terms that can be difficult to navigate without proper legal advice.
- Forfeited Equity: If you decide not to buy the property after the lease period, any additional funds you’ve paid towards the future purchase might be forfeited.
- Resale Limitations: In some cases, lease-to-own agreements might include clauses that restrict your ability to sell the property during the lease period.
5. FINANCING WITH A USDA AG LOAN
Lastly, USDA Ag loans are the last common type of financing that is being used to purchase property in America. USDA Ag loans come with an array of highly specific prerequisites, encompassing both loan approval and eligibility. It’s essential to directly contact your local USDA office for more information. Do this either by visiting in person or through a phone inquiry. In my conversation with our local ag office, I gained insight to their application approval. it was evident that they engage in comprehensive interviews with each applicant prior to determining loan approval. A friend of mine is presently submitting property offers with a USDA loan, and she shared that they mandate a closing date set at least 6 months ahead. This requirement is often unattractive to sellers and might impact the appeal of your offer. Below are list of pros and cons, for more information visit USDA AG Loans.
Pros
- Low Down Payment: Often require lower down payments compared to conventional loans.
- Flexible Credit Requirements: These loans have more lenient credit score requirements.
- No Private Mortgage Insurance (PMI): Do not require PMI, which can significantly reduce monthly mortgage costs.
- Competitive Interest Rates: Typically offer competitive interest rates.
- Rural Property Eligibility: These loans are designed for properties in rural areas.
- Property Improvement: This loan can be used not only for purchasing a home but also for land development and improvements related to agricultural operations.
- Support for Farmers: If you’re interested in pursuing farming or agricultural activities, a USDA Ag Loan can provide financial support to start or expand your operations.
- Government Backing: USDA Ag Loans are backed by the government, providing added security for lenders and borrowers.
Cons
- Income Limits: These loans have income limits based on the area’s median income. If your income exceeds the limit, you may not qualify for this type of loan.
- Property Eligibility: The property must meet specific eligibility criteria, including being in a rural area and meeting certain safety and livability standards.
- Appraisal and Inspection: Often require a property appraisal and inspection to ensure it meets health, safety, and livability standards.
- Loan Fees: While having lower interest rates, they may come with additional fees. Such as an upfront guarantee fee and an annual fee. These fees can add to the overall cost of the loan.
- Loan Processing Time: Due to government regulations and requirements, the loan application and approval process for USDA Ag Loans take longer compared to conventional loans.
- Limited Refinancing Options: Refinancing may be more challenging, as other lenders may have stricter criteria for refinancing these types of loans.
- Lack of Flexibility: The loan terms and conditions may be less flexible compared to conventional loans. This could impact your ability to negotiate specific terms.
- Resale Restrictions: If you decide to sell the property, certain USDA Ag Loans may have restrictions on who can purchase the home. This could limit your potential buyer pool.
- Loan Availability: USDA Ag Loans may have limited availability, and not all lenders offer these types of loans. This can reduce your options for choosing a lender.
- Documentation Requirements: These may come with stringent documentation requirements, which can be time-consuming and cumbersome.
- Additional Requirements: Depending on the program, there may be additional requirements you need to meet. These may include items such as participating in certain educational programs.