It is strange name but the concept is simple. This is a mortgage that is given to the buyer, by the seller as part of the transaction.
This is also known as seller or owner financing. This type of arrangement usually happens in situations where the buyer cannot qualify for a traditional mortgage from a lender.
What are the Basics of a Purchase Money Mortgage
This is not like a traditional mortgage. Rather a purchase money mortgage is where the seller gives the buyer a mortgage. The buyer and seller will agree on an interest rate, monthly payment amount and the terms of the loan.
Purchase Money Mortgage Benefits for Buyers
The purchase money mortgage is a lot more beneficial to a buyer versus a traditional mortgage. As part of the process, it is common that a seller will request a credit report on the buyer. The seller’s criteria for the buyer to qualify will be much more flexible than those of conventional lenders.
Buyers can chose from a number of payments options. Some of these payment options include, interest only, or balloon payments.
Down payments are also negotiable. If a seller prefers a larger down payment, this can be negotiated. The seller may allow the buyer to make lump sum payments on a periodic basis towards the down payment. Closing costs with a purchase money mortgage are lower as well. When you are not using a traditional lender, there are no processing or administrative fees.
Purchase Money Mortgage Benefits for Sellers
The greatest benefit to the seller is that they will likely receive full list price or higher on the sale of their property. If the seller does an instalment sale, they may also pay less in taxes. Routine payments from the buyer will likely provide the seller positive cash flow. A Seller may also be able to negotiate a higher interest rate than in a bank savings’ account or other low-risk investments.
How Purchase-Money Mortgages Work
There are 2 types of purchase money mortgages.
The first is called a land contract. In this arrangement you make your down payment and agree with the seller on other terms like the length of the mortgage as well as interest rate.
The other arrangement is with rent-to-own homes. With the rent-to-own arrangement the buyer can purchase the home at the end or during the lease term, depending upon how the contract was constructed. Land contracts are different in that they are used when the purchaser typically cannot get a mortgage.
Both the land contract and rent-to-own options have 2 clear advantages. Number one, you can get approved with sub par credit. Number 2, you can agree upon the purchase price in advance, before market conditions cause the value of the home to go up more in value. There are however some draw backs to both options.
Since you have sub par credit in both cases, the seller may ask for a higher down payment and you might be subject to larger closing costs.
How Does Title Transfer Work With a Purchase Money Mortgage
With land contracts, you do not get the title to the home right away. You get title once it is refinanced into a traditional mortgage or once you make the final payment. If you are looking at the rent to own option (also referred to as lease purchase agreement), you will get equitable title, but you have to buy at the end of the lease. Remember that laws will vary depending upon what state you live in, so it is a good idea to consult an attorney.
What Happens To Existing Mortgages In a Purchase Money Mortgage Agreement?
If there is an existing mortgage it is possible for you to assume the seller’s payments (if you are the buyer). However, there are 2 important things for you to know about regarding this.
First, this is a weird concept, but when you assume the other person’s loan, you could end up making two payments at different interest rates. You are going to have the payment from the existing mortgage, but chances are good that the sale price is higher than the existing mortgage balance in most cases we are willing to bet. When this occurs, you are going to have a separate agreement with the seller with respect to term and interest rate for the difference between the purchase price and the existing mortgage balance. Sounds confusing, doesn’t it?
Here is the second important thing that you need to know. If you plan to officially assume the existing mortgage, you will have to qualify with the mortgage company. This means that you will need a good credit history.
the problem with a purchase money mortgage
The big problem with a purchase money mortgage is that people are looking for this mortgage because they cannot qualify for a regular mortgage. If you cannot qualify for a traditional mortgage, and if you do not have a downpayment, then you are not a good candidate. A purchase money mortgage will make the most sense when you can make the payment on the mortgage, but don’t have enough money to put down as a deposit. As a result, you work out an arrangement with the seller.
Pitfalls Of a Purchase Money Mortgage
There are a number of potential hazards to look out for. Here they are in no particular order:
- Higher sale price and higher monthly payments: In this arrangement, sellers are taking on additional risk by handling financing as such, they will likely expect a higher sale price and thus higher payments.
- Higher interest rate: If a seller cannot get a higher price for taking the risk, they may charge a higher interest rate than what you would get with a traditional mortgage. In some cases, the price and interest rate will be higher.
- Lose the House Through No Fault of Your Own: If you choose to pay the seller on a monthly basis, while they make their mortgage payment on the existing mortgage, you’re taking a big risk yourself that they’ll make those payments to the mortgage company. If they don’t make the payments, they lose the house and you get kicked out. It is a horrible scenario, but it happens often.