What is a purchase money mortgage?

Borrowers usually opt for a purchase money mortgage if they are unable to qualify for a conventional mortgage. This is also known as seller or owner financing. This loan is provided by the owner of the property you wish to purchase. Borrowers with a high debt-to-income ratio, poor credit score, or a small down payment generally choose this option.

How does a purchase money mortgage work?

The owner or seller sets the loan terms — down payment, interest rates, loan terms, fees, and eligibility — for the mortgage agreement. There isn’t a lengthy underwriting process or dealing with lenders. but borrowers may have to make a balloon payment (a lump sum of the remaining mortgage balance to close off the loan) at the end of the loan term. The buyer makes monthly payments according to the amortization schedule (a schedule that lays out when and how much mortgage to pay and how much of the amount goes towards the principal and interest). The borrower will pay property taxes and homeowners’ insurance premiums separately. 

With a purchase money mortgage, the seller holds the property deed until the loan repayment is complete. 

There are five types of purchase money mortgages:

• Land contract: With a land contract the seller/lender and the borrower sign an agreement to sell/buy the home and the land it is built on. 

1. 1. Lease-to-own: A lease-to-own agreement gives the tenant the option to buy the house during the lease term or when it expires. One part of the monthly rent goes towards the down payment for the house. If the borrower changes their mind, the extra funds simply go to the seller/lender.

• Lease-purchase agreement: With this agreement, the borrower agrees to buy the home before the lease period ends.The borrower/buyer pays an extra fee to get exclusive rights to buy the home at a later point.

1. Assuming the seller’s mortgage: The buyer can also choose mortgage assumption. This is beneficial to the borrower/ buyer if the current interest rates are higher than the owner’s original mortgage rate. Government-backed loans like the Federal Housing Administration loan, the U.D Department of Agriculture loan, and the Veterans affairs loans are assumable after meeting certain criteria. Conventional mortgages are not assumable. The lender has to approve the assumable mortgage. 
2. Hard money loan: This is a short-term loan borrowers take from private companies or individuals where the home is the collateral. The approval is faster because lenders are interested more in the home value than the prospective buyer’s credit history. But these loans have a higher interest rate.

Pros and cons

1. You can get loan financing without a great credit history.
2. Closing the deal is faster than the usual process. 
3. Due to reduced underwriting formalities closing costs are lower.
4. The borrower and lender can negotiate all the loan terms to best suit their needs.
5. A large balloon payment may be difficult to pay off at once without prior planning. 
6. Some sellers may not accept buyers with a poor credit score. 
7. Interest rates are higher. 
8. The due-on-sale requirement may discourage sellers from opting for this type of financing.