What happens when you are unable to qualify for a traditional mortgage while buying a new home due to poor credit or high debt to income?
Well, there is an option where a buyer can get a purchase money mortgage to purchase the property. In this post, we will understand what is a purchase money mortgage in detail.
Also known as owner or seller financing, a purchase money loan is a type of mortgage where the borrower gets finance from the seller instead of a traditional mortgage lender to purchase a property.
The purchase money mortgage is usually taken by the borrowers who are unable to qualify for a standard mortgage through traditional mortgage lenders through conventional or other government programs.
This is a good option for borrowers with bad credit or high debt-to-income ratios. There are different types of purchase mortgage loans depending on the purchase transaction.
There are three types of purchase money mortgages.
The land contract is one of the popular types of seller financing for homebuyers who are unable to qualify for standard mortgages at the moment, however, plan to be able to qualify in the coming future.
In a land contract, the homebuyer makes payments to the seller monthly for the period agreed in the contract post which there is a balloon payment towards the end of the contract.
To get the title of the property the buyer either needs to make the complete payment of the loan in the given time either through balloon payment through cash or by refinancing.
This is a good option for buyers who are building their credit and want to qualify for a traditional mortgage in the future.
If the homebuyer is unable to make the payments according to the contract, the seller has the right to cancel the contract and sell the property to someone else.
This will cause the buyer to lose all the investment he or she has made till the time.
A lease option agreement is a type of seller financing where the buyer signs an agreement with the buyer to lease the property till they decide to purchase it just before the agreement ends.
In a lease option agreement, the buyer and seller decide what is the least amount going to be for the property for the set period along with the additional payment that the buyer will be making as a down payment to the seller.
Thirty days before the contract ends, the buyer can negotiate the term of the contract stating whether or not he/she is going to purchase the property, wants to extend the contract, or wants to back out of the contract.
This is one of the best options for buyers who are uncertain if they can qualify for a traditional mortgage in the future or if the real estate market is going to change.
Just like a lease option agreement this type of seller financing includes both buyer and seller signing the contract to lease the property till the lease agreement expires.
The only difference is that, once the agreement expires, the buyer would not be able to negotiate the term of the contract.
No matter what the situation is the buyer needs to either get traditional financing or come up with a balloon payment to purchase the property.
Failing to do so, the buyer will lose the amount that he/she has invested during the lease agreement period and the seller can resell the property in the open market.
This is one of the best options for the borrowers who know that they are unable to qualify for a traditional mortgage for now, however, would be able to do so in the coming few years.
As there are benefits, there are risks involved in getting a purchase money loan to buy a property.
If you are in a situation where you need to get this type of financing, make sure you check if the title of the property is clear, there are no liens on the property, and you are sure of getting a mortgage in the coming few years.
A mortgage provided to the borrower by the seller of a home in the course of the purchase transaction is termed as a purchase money mortgage.
It is also called seller or owner financing, in situations when the buyer cannot qualify for a mortgage through traditional lending channels this purchase-money mortgage is done.
This mortgage can be used when the buyer is taking over the seller’s mortgage, and the seller finances the difference between the balance on the assumed mortgage and the market price of the property.
A purchase-money mortgage is different from a traditional mortgage. Instead of securing a mortgage through a bank, the buyer provides the seller with a down payment and gives a financing instrument as confirmation of the loan.
To protect both parties from future disputes, the security instrument is recorded in public records.
When the lender expedites the loan upon sale due to an alienation clause only then it is relevant to know if the property has an existing mortgage or not.
When the seller has a clear title, the buyer and seller come to a consensus on the interest rate, monthly payment, and loan term. The buyer pays the seller on an installment basis for the seller’s equity.
Even if land contracts do not pass legal title to the buyer, yet it gives equitable title to the buyer.
The seller is made payment for a set time period by the buyer. The buyer receives the deed after he makes the final payment or refinances.
With a lease-purchase agreement, the seller gives the buyer equitable title and leases the property.
The buyer receives the title and credit for part or all of the rental payments toward the purchase price after he fulfills the lease-purchase agreement, and then he obtains a loan for paying the seller.
Even if the seller wants the buyer’s credit report, the indicator for the buyer’s eligibility is more flexible than those by the conventional lenders.
For payment options, buyers may choose from interest-only, fixed-rate amortization, less-than-interest, or a balloon payment.
Based upon a borrower’s needs and seller’s discretion the buyers may mix or match the payments, also the interest rates may periodically adjust or remain constant.
The buyer can negotiate down payments. If the buyer is unable to manage a larger down payment that the seller quotes, then the seller may allow the buyer to make periodic lump-sum payments toward the down payment.
Closing costs are also lower. Since this is minus an institutional lender, the buyer doesn’t need to pay for the loan or discount points or origination, processing, administration, or other fees, which lenders usually charge.
Unlike the conventional loan, buyers are not dependent on lenders for financing, resulting in closing the deal faster and receive possession much earlier.
When providing a purchase-money mortgage for a home, the seller may receive full list price or higher. On an installment sale the seller may also pay less in taxes.
Payments made by the buyer could increase the seller’s monthly cash flow, and provide spendable income. Compared to a money market account or other low-risk investments the sellers may also carry a higher interest rate.
Compared to traditional bank mortgages the purchase money mortgages have higher interest rates.
These mortgages are often used by buyers who do not have enough savings to cover a traditional down payment, or by those who have poor credit and cannot get a large enough bank mortgage.
Under the terms of the contract for deed, the buyer is given possession of the property and equitable title to the property, but the legal title is held by the seller and the seller is primarily liable for payment of any underlying mortgage.
When you are buying or selling a home, a seller refinancing may be used as a substitute for a mortgage.
A real estate agreement where the seller takes care of the mortgage process instead of a financial institution is called seller financing.
Here the buyer signs a mortgage with the seller instead of applying for a conventional bank mortgage.
Seller financing is at times also called owner financing. A purchase-money mortgage is another name for seller financing.
Those buyers who have poor credit find it difficult to get a conventional loan, they get attracted to seller financing. Seller financing is not like a bank mortgage, it involves few or no closing costs or and at times may not even require an appraisal.
Unlike banks, sellers are often more flexible with the amount of down payment. Another advantage is, the process of seller-financing is much faster and often done in a week’s time.
When sellers, finance the buyer’s mortgage the process of selling a house becomes much easier. Buyers may prefer seller financing when the real estate market is down, and when the credit is tight.
Moreover, for offering to finance the sellers can expect to get a premium, which means a stronger possibility of getting their asking price in a buyer’s market.
Along with the overall tightness of the credit market, seller financing rises and falls in popularity.
Seller financing can make it possible for many more people to buy homes especially at times when the banks are avoiding risks and are willing to lend money only to the most creditworthy borrowers and not others.
It is also easier to sell a home with seller financing. The seller financing is less appealing when the credit markets are loose, and banks are willingly lending money.
The main drawback with seller financing is the buyers will almost surely pay higher interest compared to a market-rate mortgage from a bank.
Seller financing does not have more flexibility in changing the interest rate charged by offering non-conventional loans as the financial institutions have. In long term, the higher interest could eliminate the savings gained by avoiding closing costs with seller financing.
Even with seller refinancing the buyers need to show their ability to repay back the loan.
Like other real estate purchases, a seller financing buyer will need to pay for a title search to guarantee the deed is accurately described and free from impediment.
Other charges like the survey fees, document stamps, and taxes may also have to be paid. You as a seller are in a situation where like the banks, you don’t have a staff of employees who can chase down the defaulter or file foreclosure notices for you.
Maximum the court could order the buyer to reimburse those costs, but if the buyer claims bankruptcy, it will be a difficult situation.
The seller should have a mortgage note on the property, stating that it has a due on sale clause or an alienation clause. When the property sells, these clauses require full repayment of the current mortgage.
Both the buyer and sellers should engage experienced real estate attorneys to draft the paperwork while closing the deal and to make sure that all clauses and events are covered.
The buyer purchases a home directly from the seller, in a seller-financed sale and the arrangements are handled by both parties.
Seller financing often includes a balloon payment after many years of the sale.
When financing a sale of your home as a seller there are risks involved. If the buyer defaults you also as the seller, could incur heavy legal fees when you have to fight it out legally.