A purchase money mortgage is a way to qualify for a loan even if you have poor credit. Instead of a financial institution issuing the loan, the seller of the property issues it to the borrower. While a good option for those with a poor credit score, purchase money mortgages can sometimes have high interest rates and larger monthly mortgage payments.
Mortgage loans can be difficult to get if you have a high debt-to-income ratio or poor credit history. There are, however, options for those who cannot qualify for a mortgage through traditional lenders. In the case of a purchase money mortgage, the seller is the one who issues a loan to the borrower, not a financial institution, such as a bank or credit union. Purchase money mortgages exist for buyers who want to purchase a home but do not qualify for a mortgage loan.
While purchase money loans are a great pathway for some to own property, there are some definite risks involved. It is important to keep the pros and the cons in mind when deciding which route to take toward owning a home.
What is a purchase money mortgage?
A purchase money mortgage is when a seller provides the buyer a mortgage. This is an option for when the borrower cannot get a mortgage loan through traditional means. A borrower may opt for a purchase money mortgage if their debt-to-income ratio is too high, if they have a poor credit score, or if they have no credit history. Typically, the buyer will still have to pay an initial down payment.
A purchase money mortgage is also referred to as a purchase money loan, owner financing, or seller financing.
The basics of a purchase-money mortgage
The seller has a lot of flexibility when setting the terms for a purchase money loan. They can set the down payment, interest rate, and closing costs. The seller also sets the loan terms and monthly payment frequency.
As with a traditional mortgage loan, a purchase money loan is registered with the county. This protects both the buyer and the seller.
With purchase money loans, the seller holds the deed to the home, whereas a bank holds the deed with a traditional mortgage.
What happens to the the existing mortgage?
If the seller has an existing mortgage loan when selling their property, their payments for the existing mortgage may be transferred onto the purchase money loan. There are two things you should be aware of where existing mortgages are involved:
1. You’ll make two different payments
If the existing mortgage loan is transferred to the borrower, the borrower could end up making two different payments with two different interest rates.
The borrower and the seller will have to come to a separate agreement with the existing loan. This separate agreement would cover the interest rate and the difference between the existing mortgage price and the purchase price.
2. You’ll have to qualify with a mortgage company
If the buyer takes on the existing mortgage, they will have to qualify with a mortgage company. This means the buyer will need a reasonable credit history and a manageable debt-to-income ratio.
The best scenario in which to take this option is if the buyer can make the payments but does not have much cash for a down payment. In this case, they can work something out with the seller. Otherwise, a seller’s existing mortgage could take away from the benefits of a purchase money loan.
Types of purchase money mortgages
A land contract is a mortgage from the seller. The buyer pays the seller the down payment and interest rate. When the buyer pays off the mortgage, the deed is transferred from the seller to the buyer. The buyer then owns the property.
Lease option agreement
A lease option agreement is a rent-to-own situation. The borrower has the option to buy the property during the lease or when it expires. Monthly rent usually goes toward the down payment to purchase the home.
Lease purchase agreement
Also known as a rental agreement, a lease purchase agreement requires the tenant to buy the property during the lease or when it expires.
Assuming the seller’s mortgage
If the seller has a mortgage that will not be paid off in full before the borrower takes the property, the borrower assumes the seller’s existing mortgage. There are usually two different interest rates and terms between the original mortgage and the purchase money mortgage.
Pros and Cons of Purchase Money Mortgages
Here is a list of the benefits and the drawbacks to consider.
- Buy a home even if you’re otherwise unqualified
- Flexible down payments
- Faster closing
- Higher monthly payments
- High interest rates
- Increased sales price
- Foreclosure risk
Pros of Purchase Money Loans
Although purchase money loans should not be your first choice when financing a home, they do have some advantages that make them an option in certain circumstances.
Buy a home even if you’re otherwise unqualified
One of the biggest benefits of a purchase money loan is the ability to own a home even if the borrower’s credentials are not good enough for a traditional lender. You don’t need a perfect credit score to take advantage of purchase money mortgages.
Flexible down payments
Sellers can be more flexible with a down payment than other financial institutions. In some cases, you may end up paying less on a down payment for a purchase money loan than you would with a traditional mortgage.
Because sellers are not dealing with a bank, they can usually close the loan much faster than a traditional lender.
Cons of Purchase Money Loans
Before getting a purchase money loan consider the disadvantages that come with them.
Higher monthly payments
Monthly payments may be higher than with a conventional loan, especially if you take on the seller’s existing mortgage on top of the purchase money loan.
High interest rates
Sellers may charge a higher interest rate on purchase money loans to compensate for having to wait to get paid in installments instead of getting a lump sum with a traditional mortgage.
Increased sales price
The seller may raise the sales price of the home to compensate for the risks they are taking with a purchase money loan.
As with any loan, there is the risk of foreclosure. However, there’s an extra layer of risk with purchase money loans when the seller also has a mortgage. You could lose your property through no fault of your own even if you make all your monthly payments if the seller doesn’t make their mortgage payments.
Should you buy a home with a purchase money mortgage?
While a purchase money loan is definitely a viable option, a standard mortgage is still recommended. A standard mortgage usually comes with lower fees, better interest rates, and fewer risks. If your credit history is an obstacle to homeownership, there are many ways you can improve your credit score and strengthen your mortgage application before you opt for a seller’s mortgage.
Who holds the title in a purchase money mortgage?
The seller holds the legal title in a purchase money mortgage.
Who signs a purchase money mortgage?
The buyer signs an official financing agreement, which lays out the terms and conditions of the purchase money mortgage.
Is a refinance a purchase money mortgage?
No. A refinance is used to refinance an existing mortgage. Purchase money mortgages finance the purchase of a property.
- A purchase money mortgage is when a seller grants a borrower a mortgage as part of a transaction.
- Purchase money mortgages are for buyers who cannot get a traditional mortgage loan through the usual routes. They may have poor credit or a bad debt-to-income ratio.
- A purchase money loan gives borrowers with bad credit the ability to purchase a home.
- Although worth looking into, most homebuying experts recommend getting a traditional mortgage over a purchase money loan.
Give traditional loans a chance
A purchase money loan allows borrowers with bad or poor credit history to purchase and own property. They also do not have to go through a traditional financial institution to get a loan this way. The seller is the one financing the mortgage. However, this option comes with many risks. Therefore, a traditional loan is typically recommended over a purchase money loan. SuperMoney’s comparison tools allow you to compare lenders and filter for those that will consider your application based on your credit score, income, and debt levels.
Article Sources and Additional Reading
- Purchase-Money Mortgage – SEC
- Purchase-Money Mortgages – Cornell Law School
- Is a Purchase Money Mortgage subject to MLOLA? State of Michigan
- What is Reverse Mortgage? Should you get it instead of a personal loan? Find out
- Reverse Mortgage
Camilla has a background in journalism and business communications. She specializes in writing complex information in understandable ways. She has written on a variety of topics including money, science, personal finance, politics, and more. Her work has been published in the HuffPost, KSL.com, Deseret News, and more.