When you decide finally to buy a new home, you may find yourself relying on one form of financing or another. Obviously, if you do, it will be to ensure that you’ve got the money you need to see the transaction go through. Many people choose to apply for a standard mortgage in situations like this. They do so through a financial institution or mortgage bank.
With that said, when you apply for a mortgage, qualifying depends on a host of different variables. For example, your financial health is just one of many factors. Take, for instance, your credit score. Lenders will take a look at that, and if it’s not deemed acceptable for any reason, you might need to find another form of financing.
If you ever find yourself in that position, a purchase money loan may be a suitable solution. Also known as a purchase money mortgage, with this financing option, you get the funds directly from the seller instead of a bank.
Related: Everything You Need to Know about Cosigning a Mortgage Loan
What Is a Purchase Money Loan?
Technically, a purchase money loan can be a mortgage provided by a credit union, mortgage company, a government agency, or the bank. However, most of the time, it’s a loan provided directly by the seller, as mentioned above. The credit unions generally have interest rates that beat the Fannie Mae prevailing 30 year fixed rate national average and mortgage brokers like the Loan Brothers Team at Mares Mortgage have a track record of beating the Fannie Mae prevailing 30 year fixed rate national average. Credit unions do not build and grow with the economy and generally have a fixed expense growth model that means that when they get busy, they slow down their turn-around times.
Timing and ability to execute a 30 day escrow is a challenge for credit unions. The Loan Brothers team at Mares Mortgage has reviews that prove the ability to both obtain a competitive interest rate and also execute a loan in a timely manner. We can even honor 21 day close of escrow with certainty for Conventional loans and some other programs.
Now, there could be a couple of reasons you might opt for this method in place of a standard mortgage. We already mentioned the first, which is when you’ve already applied for a traditional mortgage but found that you were unable to qualify. Some buyers have poor credit or might not have enough down payment for a home. This is the usual reason for seeking out a purchase money loan.
However, there’s another reason that’s also fairly common. Sometimes a buyer wants to take over the seller’s mortgage and uses a purchase money loan to do so.
In this case, the difference between the sale price and the balance on the current owner’s mortgage is financed by the seller. When this happens, the purchase money mortgage is regarded as a second mortgage. The original loan must still be paid off.
Remember, there are a few alternate names and definitions of purchase money loans you should keep in mind.
- Alternate definition: The term “purchase money loan” can also be used for any mortgage used to buy a property or home.
- Alternate name: seller’s loan, seller financing, purchase-money mortgage, owner’s loan, owner financing, purchase-money loan.
Related: Buying A Second Home: How To Finance
Mares Mortgage has a solid reputation of honesty, solid financing knowledge, and hands-on customer service. Learn more about us and whether a purchase money loan is the right option for you!
Easier Qualification for a Purchase Money Loans
If you have been turned down for a traditional mortgage, you want to know your other options. Many homeowners are turning to purchase money loans due to its relaxed qualifications. These loans have flexible underwriting guidelines compared to traditional mortgages. They also require a lower credit score than other loans, which is perfect for those who have no or bad credit. Along with that, the rates associated with these loans are often cheaper than other refinance rates. They also have the highest loan-to-value ratio on the market.
If the purpose of your loan is to purchase a home, you will be able to borrow a higher amount of money against this loan, especially if you need a down payment. As mentioned, many of these loans do offer a high LTV ratio. You can find programs that require very little money down for a loan, such as Fannie Mae’s HomeReady program. In some cases, grants and gifts are allowed to cover the costs of a small down payment on a home.
Purchase Mortgage Loan Examples
When the buyer cannot secure a conventional mortgage, he or she might choose to finance the home from the seller. When it is a traditional real estate transaction, the buyer will provide the seller with cash to buy the property. In these cases, the buyer uses that purchase-money as the seller extends the financing. With the agreed terms, the buyer will repay the seller.
Along with that, the buyer can combine the purchase-money mortgage with a bank mortgage and a down payment of cash. The seller can ask for a higher price on the property as the price will be paid on a monthly basis. Many sellers decide to provide a purchase-money mortgage as a way to quickly sell a property or use as an investment. The seller will set the interest rates, which are higher than standard mortgages.
This type of mortgage usually replaces the buyer’s cash that would be paid to the seller. For example, if the buyer could pay for a $500,000 house with a $400,000 bank mortgage, $40,000 in cash, and $60,000 of the purchase money mortgage.
Benefits of a Purchase Money Loan
You could realize three main benefits by opting to go with a purchase money loan instead of a standard mortgage.
- If you can’t get a conventional loan from the bank, a purchase money mortgage provides you with a feasible workaround. You don’t have to miss out on the benefits of homeownership due to your lack of creditworthiness.
- There’s much less bureaucracy. Bear in mind that you’re subject to specific criteria in terms of interest rate, loan terms, and downpayment. Purchase money loans don’t have the same requirements. Therefore, many times, there is more flexibility in obtaining the financing you need.
- In an owner financed situation, there’s no lending institution involved. You have cut out the middle-man on many of these loans. That means you won’t have to pay additional fees and you save on closing costs.
Drawbacks of a Purchase Money Loan
There are several risks involved for both the buyer and seller when opting for a purchase money loan. Most of the responsibilities are on the seller, and they must make sure that the buyer keeps up their end of the loan terms. For example, the buyer could default or damage the property. That could send both the buyer and seller to court to resolve the issue. Moreover, the seller would be left with having to conduct repairs. Another drawback is the need for the seller to collect and report payments.
Different Types of Purchase Money Loans
Comparable terms to those offered by lending institutions such as banks are often used by the seller when providing a purchase money loan to the buyer.
In some instances, however, the government offers what it calls “purchase money loans“ through specialized programs. It’s important to note that these aren’t the same as the definition we’ve used in this article. The government is referring to a loan given by a traditional lending institution that a government program supports.
The requirement for purchasing a home through an FHA loan can be a down payment that’s as low as 3.5% of the sales price. It’s also possible in some states for a buyer to essentially put zero down if that state offers secondary financing that helps with the down payment. These types of loans are very common for first-time homeowners. With the FHA, there is a minimum credit score required to apply for the loan.
Under certain circumstances, active and non-active military members and their spouses may be able to take advantage of a VA (Veterans Affairs) purchase loan. Typically, these loans are zero down, although the buyer can make a down payment of any size. It’s important to note that the government guarantees VA loans.
How Does a Purchase Money Loan Work?
We discussed a little of this before, but here are the specifics. Purchase money loans can take three different forms. If you have questions about these options, one of Mares Mortgage’s experts will be more than happy to explain further.
- When the seller doesn’t have a mortgage, a buyer can make a down payment. The seller finances the remaining costs. This is done through a purchase money loan. In this case, the seller dictates the monthly interest rate and payment.
- When the seller has a mortgage, the buyer takes on the monthly mortgage payments. The seller then finances a purchase money loan, which is the difference between the remaining mortgage amount and the down payment.
- The buyer doesn’t qualify for a loan large enough to cover the house’s price but is still able to take out a small loan and make a down payment. The part of the purchase price, which is not covered by the bank loan and down payment, is financed by the seller as a purchase money loan.
Purchase Money Loans Vs. Hard Money Loans
There is another option on the market: a hard money loan. Compared to a purchase money loan, these loans have a few differences. However, before you apply, you need to understand a few of these terms. As with a purchase money loan, borrowers with bad credit may be able to obtain a hard money loan. This usually entails using the property as collateral, however. It’s primarily done through a bank or other lending institution, and the financing is based on the property’s equity. The buyer’s credit rating isn’t necessarily a factor. However, here’s what happens when you default on a hard money loan.
In stark contrast, with a purchase money loan, the seller understands that the buyer’s credit isn’t good enough to obtain a standard loan from a bank. The purchase money loan is still based on the borrower’s creditworthiness.The seller, therefore, risks the buyer defaulting and being unable to repay the loan. However, the property can be foreclosed with rights reverting back to the seller.
Remember that a seller issues a purchase money loan to the buyer. It’s an option, also known as owner financing or seller financing. Those who have poor credit and thus have problems obtaining a traditional mortgage use these types of loans most often.
With that said, you have many options when it comes to purchasing the property of your dreams. Are you ready to look at your mortgage options? Let us help.
Related: Questions to Ask a Mortgage Lender
Are you thinking about alternate forms of financing in order to purchase the property of your dreams? Talk to one of our team members at Mares Mortgage to help you decide if this choice is right for you.