If you want to buy a home but anticipate trouble qualifying for a traditional mortgage, a purchase-money mortgage may be a solution. Sometimes called “seller financing” or “owner financing,” a purchase-money mortgage is a loan a seller provides buyers.
While purchase-money mortgages are uncommon, negotiating this type of transaction can benefit both buyers and sellers.
Read more: What is owner financing when buying a house?
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Unlike a traditional real estate transaction, when a buyer makes an offer based on their down payment funds and a mortgage preapproval, a sale involving a purchase-money mortgage requires direct financial agreements between the buyer and seller. A house’s seller might offer a purchase-money mortgage because a prospective buyer can’t qualify for a traditional loan due to a low credit score, lack of down payment funds, or high debt levels.
If a seller is willing to offer a purchase-money mortgage, they’ll negotiate the terms of the arrangement, such as the down payment requirement, loan term length, closing costs, monthly payments, and interest rate. Since the seller sets the terms, the loan can be for a longer or shorter amount of time than a traditional mortgage loan. The interest rate may be higher than that of a traditional lender since the seller is taking on some risk to provide financing to a borrower who couldn’t qualify for a mortgage in the usual way.
The seller and buyer typically sign a promissory note agreeing to the loan terms. The purchase-money mortgage is recorded with the county government, which helps provide legal protection for both sides of the transaction. Usually, the seller holds the deed to the property until the loan is paid in full.
If the buyer defaults on the loan, the seller will have the right to initiate foreclosure proceedings according to the process established in their state.
Learn more: What is a house deed, and why is it important?
There are several types of purchase-money mortgages that sellers can offer, including:
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Land contract. With a land contract purchase-money mortgage, the two parties agree on a down payment, interest rate, and payment schedule. The buyer pays the seller until the loan is paid in full before receiving the deed to the property.
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Lease option. Renters may sign a lease with an option to buy the home from the landlords, which typically means a portion of their rent is set aside to accumulate a down payment. If the renters decide not to buy at the end of the lease term, the owners usually keep the funds that have been set aside for the down payment.
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Lease purchase. Renters may sign a lease with a commitment to buy the property at a specific time and price, such as the current market value or another negotiated price. Usually, the renters pay a fee for the sole right to buy the home at the end of the lease agreement, with some of the rent set aside by the owner for a down payment.
Dig deeper: What are the types of rent-to-own agreements, and can they help you buy a home?
There are many possible scenarios since purchase-money mortgages are negotiated directly between sellers and buyers rather than through a financial institution. Here is a typical example:
A buyer wants to purchase a $300,000 home. They have $50,000 for a down payment — but they cannot qualify for a mortgage for the remaining $250,000 because they have a low credit score due to a lingering bankruptcy report from a few years ago.
The seller could offer a purchase-money mortgage for the $250,000 for a 15-year term at 7.5% interest for a monthly payment of about $2,317.
Keep learning: How bankruptcy affects keeping and buying a home
Sellers who want to offer a purchase-money mortgage should consider the potential risks and rewards.
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In exchange for helping the buyer with financing, you may receive the total purchase price or more for your home.
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The monthly mortgage payments from the buyer can add to your cash flow.
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You can charge more than the interest rate you would earn on low-risk investments, such as a high-yield savings or money market account.
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You may be able to close on the sale more quickly than with traditional financing.
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There are possible tax benefits due to the deferred payments.
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You won’t receive a full lump-sum payment for your home.
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You’re loaning money to a potentially risky borrower.
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If the borrower defaults, the foreclosure process could be long and complicated.
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Since the deed to the property is in your name, you may continue to be responsible for any problems with the house.
Buyers who can’t qualify for a traditional loan may gain access to homeownership with a purchase-money mortgage, but this option has advantages and disadvantages.
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You might be eligible to buy a house with more flexible qualifications than going through a traditional mortgage lender.
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It’s possible to negotiate individualized payment plans, such as a term that meets your specific needs, interest-only payments for a certain period, adjustable interest rates or payments, or one or more balloon payments.
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You can negotiate your down payment or make incremental lump-sum payments toward the down payment.
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Your closing costs will likely be lower without lender fees and certain other costs.
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You may be able to close on the transaction and move in quickly.
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As you build equity and improve your credit, you could qualify to refinance into a traditional loan.
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You don’t have title to the home until the loan is fully paid.
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Your interest rate and payment may be higher than the market rate.
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You may face one or more balloon payments that require you to come up with a significant amount of cash all at once.
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You risk foreclosure if you can’t meet the purchase-money mortgage requirements, which may be more likely if your finances are not solid enough to qualify for a traditional loan.
Learn more: How long it takes to close on a house — And how to speed up the process
The seller keeps the title to the property until the purchase-money mortgage is fully paid.
Yes, a purchase-money mortgage must be recorded in the county, which protects both the buyers and sellers in case of legal action.
An appraisal is not required for a purchase-money mortgage, but buyers or sellers may want to pay for one to verify the property’s current market value.
This article was edited by Laura Grace Tarpley.
