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Loading...Loading...A purchase money mortgage is when the seller lends money to the buyer to pay for part or all of the sale. The buyer then pays the seller directly.
When someone sells a house and also lends the money, that's called a purchase money mortgage. The buyer doesn't get a loan from a bank or credit union; instead, they borrow money directly from the person who owns the property. The seller sets the interest rate, the down payment, and the date the loan is due. Just like with a regular loan, the county keeps a record of the mortgage, and both parties sign a promissory note.
Some people call this "owner financing" or "seller financing." It works the same way no matter what you call it. The house itself is what backs the loan. If the buyer stops paying, the seller can start the process of taking back the house through foreclosure.
So why would someone do this? Most of the time, it's because of problems with qualifications. The buyer might have a good job, but they went bankrupt a few years ago. Maybe they're self-employed and can't show the kind of W-2 income that banks want to see. According to the Consumer Financial Protection Bureau, lenders have to verify that a borrower can repay a mortgage, and that process often disqualifies people who are perfectly capable of making monthly payments but don't fit neatly into the underwriting box.
This is where a purchase money mortgage comes in. The seller looks at the buyer's situation, decides the risk is worth it, and makes a deal that works for both of them. But it's not a free pass. There are sometimes big trade-offs with these loans, so both the buyer and seller need to know what they're giving up and what they're getting.
More and more of my coworkers have talked about these kinds of deals in the last few years. People get creative when traditional lending is hard to come by. That ability to be resourceful can be helpful, but only if you know what you're doing.
It's not too hard to understand the basic setup. The buyer and seller talk about how much the house costs and then agree on how to pay for it. This includes the amount of the down payment, the interest rate, the length of the loan, and when the payments are due.
A promissory note is a document that both parties sign that lists all the terms of the loan. The buyer can move in and start paying right away. The seller files the mortgage with the county recorder's office, which puts a lien on the property. The lien protects the seller's money.
This is where it differs from a normal mortgage. The lender checks your credit, income, and debt-to-income ratio, and then they underwrite the whole deal before you get the money from a bank loan. With a purchase money mortgage, the seller gets to decide what qualifications are most important. Some sellers want to see your tax returns. Some people are more interested in a big down payment. The buyer and seller can agree on any terms.
The seller usually keeps the deed until the buyer has paid off the loan in full. With a regular mortgage, though, you get the deed at closing and the bank only has a lien.
Before signing anything, buyers need to know this difference.
Most purchase money mortgages have shorter terms than regular loans. You could get a loan with a balloon payment at the end that lasts three, five, or seven years. The idea is that the buyer will use that time to raise their credit score, stabilize their income, or save enough money to refinance into a regular mortgage with a lower rate before the balloon payment is due. When the time comes, AmeriSave will help buyers figure out how to refinance.
There are different ways to make payments. Some loans are fully amortizing, which means that the buyer pays both the principal and the interest every month until the loan is paid off. Some are interest-only with a balloon, which means that the buyer only pays interest for the term and then has to pay the full balance all at once.
There are a few different types of purchase money mortgages. The right one depends on what the buyer and seller want to do and how much freedom each side needs.
Land contracts are the most common way for sellers to get paid. The buyer and seller agree on the price, the down payment, the interest rate, and how the buyer will pay. The buyer pays the seller every month for the house.
The seller still owns the property until the buyer pays in full. After the last payment, the seller gives the deed. The seller keeps the property if the buyer doesn't pay, which protects them. This also means that the buyer doesn't have full ownership rights until the end, which could be a problem if they want to sell or make big changes during the term.
Most land contracts end with a big payment after three to five years. You need a good plan for the balloon because it costs a lot to get one.
A lease-option lets a renter try out the property before they buy it. The buyer rents the property for a set amount of time, and at the end of that time, or during it, they can choose to buy it. The word "option" is the most important one here. At the end of the lease, the buyer can walk away if they decide the home isn't right for them or if they still can't get a loan.
The seller usually wants an option fee upfront and may charge a little more each month than a normal rental would. Usually, some of those rent payments go toward the down payment. If the buyer doesn't use the option to buy, they lose that extra money. That's the cost of being able to change your mind. Before the option period ends, AmeriSave's prequalification tools can help you figure out where you stand.
A lease-option and a lease-purchase look the same, but there is one big difference. With a lease-purchase, the buyer agrees to buy the house for a certain amount of money and on a certain date. You can't just leave without dealing with the consequences. The buyer pays an option fee to get the right to buy the property, and part of the monthly rent goes toward the down payment.
If you sign a lease-purchase and then can't get a mortgage when it's time to buy, you could get in trouble with the law or lose all the money you've put down for the down payment. This structure puts more risk on the buyer, but the seller is more sure that the deal will go through.
You have $50,000 saved up for a down payment and make $85,000 a year. You want to buy a house that costs $325,000. You only have a 590 credit score, but you did a short sale four years ago. Most traditional lenders won't accept that number.
The seller agrees to a loan for the last $275,000. You agree to the terms: a 7% interest rate, monthly payments, and a five-year term with a balloon payment at the end.
If you take out a loan for $275,000 at 7% for 30 years, your monthly payment will be around $1,830. You pay that amount every month for five years, which comes to about $109,800. You still owe about $259,000 on your loan after five years of payments because most of your early payments went toward interest.
It's time to pay the $259,000 balloon payment. Your credit has had time to get better, your income may have gone up, and you've always paid your bills on time. You could get a regular 30-year mortgage with a much better rate if you take that history to a regular lender. AmeriSave has a number of refinance programs that can help you switch when the time is right.
This is how a lot of people get their purchase money mortgages to work. The bridge is the money the seller gives. The standard loan, on the other hand, is the long-term solution. But that bridge only works if you know you can get a regular loan before the balloon payment is due.
The best thing for buyers is that they can get to it. Seller financing gives you a way to buy a home that you wouldn't have otherwise if you can't get a regular mortgage right now. You don't have to wait years to fix your credit or get a longer work history before you can buy.
Also, the rules about how much you need to put down are usually more flexible. A regular loan might need 3% to 20% down, depending on the program. A seller, on the other hand, will accept any amount that makes the deal work. You can also save money on closing costs by not paying a lot of the bank's fees. According to the Federal Reserve, closing costs on traditional mortgages can add 2% to 5% of the loan amount, and seller-financed deals can trim that number. AmeriSave helps borrowers compare conventional, FHA, and VA programs to find the best one for them. If those don't work right now, a purchase money mortgage could be a good first step.
Sellers also get benefits. They can sell a property that might not sell otherwise, especially if it's in bad shape that traditional lenders would notice during an appraisal. The monthly payments provide a steady stream of income, and they might be able to get a higher sale price by offering financing. According to the National Association of REALTORS®, only about 6% of home sales happen without an agent's involvement, and seller-financed deals sometimes fall into that category.
Purchase money mortgages can be a good option, but you need to be aware of the risks that come with them.
The interest rate is almost always higher for buyers than what a bank would charge. A regular 30-year fixed rate might be between 6% and 7%, but a deal where the seller pays for it could be 8% to 10% or more. That difference adds up to thousands of extra dollars in interest payments over five years.
The balloon payment is the biggest risk of all. If you can't refinance or pay off the rest of the loan when it comes due, the seller starts the foreclosure process. That means you could lose your house and all the money you've paid so far. Things change in life. Jobs change. Rates of interest change. You can't just hope things will work out; you need a backup plan that makes sense.
Another thing to think about is due-on-sale clauses. If the seller still has a mortgage on the property, the lender may be able to demand full payment as soon as the seller gives up any interest. If no one catches this ahead of time, it will ruin the whole deal.
The biggest risk for sellers is that the buyer will not pay. If the buyer stops paying, you get the property back that you thought you had sold. Now you have to go through the foreclosure process, which can take months or longer depending on where you live. You're also putting your money into a long-term loan instead of getting a cash payout at closing.
From the start, both sides should hire a real estate lawyer. AmeriSave always suggests hiring a lawyer when the deal structure is more complicated than a regular mortgage. Paying for legal help upfront will save you money in the long run.
The Dodd-Frank Wall Street Reform and Consumer Protection Act put guardrails around seller financing to protect buyers. If you sell one property with owner financing in a 12-month period and you're a natural person (not a corporation or LLC), you avoid being classified as a loan originator under federal rules. But the loan still has to meet certain requirements.
According to the Consumer Financial Protection Bureau, under the one-property exception, the loan can't have negative amortization, and the rate has to be fixed or adjustable with a reset period of at least five years. If you finance the sale of two or three properties in a 12-month period, the rules get tighter. The loan has to be fully amortizing, and you have to make a good-faith determination that the buyer is able to repay.
If a seller finances more than three properties in a year, they become a full loan originator and have to follow all of the rules and regulations that come with that. And builders or contractors can't use the one-property exception at all.
These rules are in place to stop seller financing from becoming predatory lending. They don't cover everything, and state laws add their own rules on top of them. Before they write anything down, both buyers and sellers need to know the rules that apply in their state.
If you can't get a loan from a bank, a purchase money mortgage will let you in. But be careful about what you're getting into. Know what the interest rate is. Find out how much the balloon is worth. Make sure you know how you're going to refinance before that balloon comes due. Hire a lawyer. Read all of the documents. Don't sign anything until you know exactly what will happen if you miss a payment or can't pay the balloon, either. AmeriSave will help you look at your financing options and show you traditional, FHA, and VA programs that might be better for you than you think.
The seller gives you a purchase money mortgage so you can buy their home instead of getting the money from a bank. You pay the seller directly each month until the loan is paid off or you refinance. This is the most common way to set things up when people can't get a regular loan because of bad credit, trouble proving their income, or other things that make it hard for banks to approve loans. The mortgage Resource Center at AmeriSave has more information about how different types of loans compare. You can also use their prequalification tool to look at your options.
The main difference is who has the money and who is at risk. A bank or lender pays for a regular mortgage and keeps the lien. A purchase money mortgage has the seller as the lender. The buyer and seller agree on the interest rates, qualifying standards, and terms. This means they can be more flexible, but it usually costs more. Federal rules for traditional lenders are very strict, but sellers have more leeway. On AmeriSave's mortgage rates page, you can see how regular loans stack up against other kinds of loans.
Yes, and that's what most people who buy one plan to do. The goal is to improve your credit, stabilize your income, or wait long enough after a money problem to be able to get a regular mortgage. Most purchase money mortgages have short terms and balloon payments, so refinancing is not just an option; it's a must. When you're ready, AmeriSave's refinance programs can help you get a regular loan at a lower interest rate. You can find out where you stand by using their prequalification tool.
The seller can start the process of foreclosure if the balloon comes due and you can't pay it off or refinance. That means you could lose the house and all the money you've put into it. Some sellers may agree to extend the term or renegotiate, but they don't have to by law. That's why it's so important to have a realistic plan for refinancing before the balloon payment is due. Before your balloon date, make sure you can get a conventional loan from AmeriSave or an FHA loan.
Not very often. Most seller-financed deals say that the seller keeps the deed until the loan is paid off in full. You can live in the house, but you don't own it outright until the last payment is made. With a land contract, the seller keeps the legal title the whole time. In a regular mortgage, you get the deed at closing and the lender only has a lien. This is a big difference. A regular mortgage from a lender like AmeriSave might be a better choice if you want the deed right away. On AmeriSave's purchase page, you can see what you can buy.
Interest rates on seller-financed deals are usually higher than those on regular mortgages because the seller is taking on more risk. A regular mortgage rate could be between 6% and 7%, but a purchase money mortgage could have rates of 8% to 10% or even higher, depending on the buyer's credit and how much risk the seller is willing to take. The buyer and seller agree on the exact rate. For the most up-to-date information on how current conventional rates compare, visit AmeriSave's rate page. You can also prequalify with AmeriSave to find out what traditional options might be available to you.
All 50 states allow seller financing, but the rules are not the same in all of them. The Dodd-Frank Act sets the lowest standards for the federal government. State laws add their own rules on top of those. Some states require that certain information be made public. Some people set a limit on the interest rate that a seller can charge. The Consumer Financial Protection Bureau says that sellers who finance more than a certain number of deals each year must follow the rules for loan originator licensing. Always hire a lawyer who specializes in real estate in your state to make sure the deal is legal. If you want to look at your options, AmeriSave's Resource Center has information on different loan structures.
Yes, but they are usually cheaper than bank loans. You probably won't have to pay for things like loan origination fees, bank appraisal fees, and some of the processing costs that regular lenders charge. You will still probably have to pay for a title search, title insurance, recording fees, and lawyer fees, though. The Federal Reserve says that normal closing costs can add 2% to 5% to the amount of the loan. Deals where the seller pays for everything can lower that range. You can save $2,750 on a $275,000 loan if you cut the closing costs by just 1%. If you choose the traditional route, AmeriSave's closing cost resources can help you know what to expect.
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