In a purchase-money mortgage transaction, the home seller acts as a lender and sets the down payment and interest rate.
A purchase-money mortgage or seller financing, is issued by the home seller instead of a bank or credit union as part of the purchase transaction. This can be an excellent solution for buyers not qualifying for a conventional mortgage. In some cases, the buyer may assume the seller's mortgage and the difference is made up with seller financing.
A purchase-money mortgage offers people with less-than-perfect credit the chance to buy a home with financing. However, this option has pros and cons. It is important to understand the risks and advantages before entering a purchase-money mortgage.
- What is a Purchase-Money Mortgage?
- Pros
- Cons
- See All 8 Items
What is a Purchase-Money Mortgage?
A purchase-money mortgage is where a homeowner takes the place of a bank or credit union in the home buying process.
“Basically, the seller would act as the lender and offer terms (down payment, interest rate, etc.) and the seller would still hold the mortgage but act as the bank,” says Elevation Mortgage's mortgage broker and owner.
This differs from a traditional mortgage in that the buyer won't apply for the mortgage with the bank. In some cases, the buyer assumes the seller's mortgage and the seller finances the difference between the outstanding mortgage balance and the home sale price.
“It is a legitimate way to buy a home; however, in some cases, this can be a legal nightmare for both parties,” Letson says. “There has to be a level of trust involved, as well as a real estate attorney.”
Therefore, Letson often recommends against this type of mortgage financing, “especially between friends or family as I have seen this situation get pretty ugly and ruin relationships.” The only exception, he says, is if there’s a business relationship and all parties have agreed to the terms of the deal.
“Lastly, this can be a great option if the seller is offering better terms (lower down payment and interest rate) than what is currently available in the open market,” he adds.
Pros
- Unqualified borrowers have more options to buy a home
- Lower closing costs
- Flexible down payments
- Faster closing process
Cons
- Higher interest rates
- Higher monthly payments
- Balloon payment requirements can be high
How Does a Purchase Money Mortgage Work?
Instead of obtaining a mortgage through a bank, the buyer makes a down payment to the seller and gives a financing instrument as evidence of the loan. A purchase-money mortgage security instrument is recorded in public records to protect both parties from future disputes.
The simplest form of a purchase-money mortgage happens when the seller has a clear title. Then, the buyer and seller agree on an interest rate, monthly payment and other loan terms.
After the agreement, the buyer will pay the seller monthly installments at the agreed-upon rate until the home is paid for in full. If the property has an existing mortgage, the lender may agree to transfer the mortgage to the buyer. If the original lender has an alienation clause, the mortgage balance will be due on sale, paid by the seller or the buyer.
For example, Fred and Jane sell their ranch home to move into a retirement property. The home's market value is $400,000. They have paid off the mortgage and own the home outright.
Lila puts in an offer on the home for $400,000 but requests a purchase-money mortgage. She has $20,000 saved for the down payment. Fred and Jane accept the offer with a 9% interest rate and agree to a 20-year repayment period.
That means Lila agrees to pay $3,843.96 monthly for the principal plus interest. Of course, if interest rates on mortgages go down in the future, she can choose to get a conventional mortgage and repay Fred and Jane in a lump sum.
Is a Purchase-Money Mortgage a Good Idea?
A purchase-money mortgage offers more homebuyers the option to secure a property. However, it comes with the risk of higher interest rates, the expectation of a balloon payment and the risk of losing the home if you miss a payment. For many borrowers, a purchase-money mortgage offers the option to purchase a home when they might not qualify for a traditional mortgage.
Ready to explore other options? Compare the best mortgage lenders to find an option that fits your needs.
Why You Should Trust Us
Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial professionals and homeowners, such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who’s won awards for his New York City economy coverage. He’s navigated tricky real estate markets in New York, Northern Virginia and North Carolina.
For this story, we worked with Reed Letson, a mortgage broker and owner of Elevation Mortgage in Colorado.
Frequently Asked Questions
How does a purchase money mortgage work?
A purchase money mortgage works by having the seller act as the lender, setting the down payment and interest rate for the sale of a home. The buyer will make monthly payments to the seller.
What is the disadvantage of a purchase money mortgage?
The disadvantage of a purchase money mortgage is that it can create a complicated legal situation and you’ll likely pay a higher interest rate than if you secured a mortgage through conventional means.
What is the difference between a purchase money mortgage and a land contract?
A purchase-money mortgage gives the buyer immediate ownership of a property, whereas a land contract states that the seller owns the estate until all payments are made as agreed to in the contract.
Sources
- Reed Letson, mortgage broker and owner of Elevation Mortgage
About Anthony O'Reilly
Anthony O’Reilly is an updates editor for Benzinga. He’s won numerous journalism awards for his coverage of the New York City economy and Long Island school district budgets.
