With a purchase-money mortgage, the seller finances part or all of the property for the buyer, who usually does not qualify for traditional financing.
Keep reading to learn about the benefits and drawbacks of a purchase-money mortgage.
What Is a Purchase-Money Mortgage?
A purchase-money mortgage is also known as owner financing. The seller extends credit to the buyer to purchase the property. This can be a portion of the sales price or the full price.
In other words, the buyer borrows from the seller instead of from a traditional lender. The seller ultimately determines the interest rate, down payment, and closing costs. Both parties sign a promissory note.
They record a deed of trust or mortgage with the county. The seller usually retains title until the financed amount is paid off.
A purchase-money mortgage is a nontraditional financing method that may be needed when the buyer cannot obtain one of the other different mortgage types for purchasing the property.
The promise to pay is secured by the property, so if the buyer stops paying, the seller can foreclose and get the property back.
Recommended: How to Buy a Foreclosed Home the Simple Way
Purchase-Money Mortgage Example
Not all buyers have financial situations that make it easy for them to get a conventional mortgage. Even diligent shopping for a mortgage may not help them get the home loan they need.
If a buyer has a profitable business, for example, but doesn’t have two years of tax returns to prove steady cash flow, most mortgage lenders won’t take on the risk.
Enter a purchase-money mortgage. With the right property, seller, and situation, a buyer could finance the home with a purchase-money mortgage. The seller would offer terms to the buyer — usually a higher interest rate and a short repayment term, with a balloon mortgage payment at the end — and the buyer would enter into the agreement. The seller would hold title until the loan payoff.
Buyers and sellers who work with seller financing often intend for the purchase-money mortgage to be refinanced into a traditional mortgage with a lower mortgage payment at a later date.
Types of Purchase-Money Mortgages
Purchase-money mortgages can come in several forms.
Land Contract
A land contract (also called a contract for deed) is simply a mortgage from the seller. The buyer takes possession of the property immediately and pays the seller in installments.
Land contracts are often for five years or less, ending with a balloon payment.
Lease-Purchase Agreement
In a lease-purchase agreement, the buyer agrees to rent the property for a specified amount of time and then enter into a contract to purchase the property at a price that’s the current market value or a bit higher.
For this and a lease-option agreement, the seller typically requires a substantial upfront fee, an above-market lease rate, or both. Part of the monthly rent payment goes toward the purchase price.
Lease-Option Agreement
A lease-option agreement is similar to a lease-purchase agreement in that the buyer agrees to first rent the property for a specified amount of time. But with this agreement, the buyer has the option to purchase the property instead of making a commitment to purchase it.
Benefits of Purchase-Money Mortgages for Buyers
• Buyers, including first-time homebuyers, may be able to obtain housing sooner than if they were to wait to qualify for a traditional mortgage through a lender.
• The down payment may be more flexible for a purchase-money mortgage.
• Requirements may be more flexible.
• No or low closing costs.
Benefits of Purchase-Money Mortgages for Sellers
• The seller may be able to get the full list price from a buyer who needs the seller’s help to obtain a mortgage.
• The seller may be able to make some money by acting as the lender, including asking for a down payment and a higher interest rate.
• Taxes may be lower as the amount is financed over time.
Recommended: How to Navigate the Mortgage Preapproval Process
Weighing the Pros and Cons of Seller Financing
If you have the option of financing with a purchase-money mortgage, you will want to look at all the angles. It may also be useful to use a mortgage calculator tool to help you determine what a potential payment on a purchase-money mortgage might be.
| Pros | Cons |
|---|---|
| Buyer may be able to obtain the home with a purchase-money mortgage when other types of financing would be denied | Buyer will not have full title until the total amount borrowed is paid off |
| Flexible financing allows the seller to help the buyer purchase the property | Buyer may have little negotiating power when forging the deal |
| Increased equity may allow buyer to refinance into a traditional mortgage at the end of the purchase-money loan term | Seller is able to determine the rate, term, and down payment |
| Seller can foreclose if the buyer does not meet contractual obligations |
The Takeaway
If you’re able to secure financing from a seller, a purchase-money mortgage may be a good fit — if you have an exit plan in a few years. It’s smart for both buyers and sellers to know the risks and rewards of a purchase-money mortgage.
Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.
FAQ
Who holds the title in a purchase-money mortgage?
The seller controls the legal title; the buyer gains equitable title by making payments.
Can a bank issue a purchase-money mortgage?
Yes, but it is not common. A buyer might pay for a house with a bank mortgage, cash, and a property seller mortgage. When the bank is aware of the amount financed by the seller, both the mortgage issued by the third-party lender and the seller financing are considered purchase-money mortgages.
Does a purchase-money mortgage require an appraisal?
Not if the seller does not require one. With owner financing, the seller sets the terms, which may not include an appraisal.
Photo credit: iStock/MicroStockHub
SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.
SoFi Mortgages
Terms, conditions, and state restrictions apply. Not all products are available in all states. See SoFi.com/eligibility-criteria for more information.
*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
This article is not intended to be legal advice. Please consult an attorney for advice.
SOHL-Q324-039