Real estate has many complex terms and “purchase money mortgage” is one of them. If you’ve asked yourself “what is a purchase money mortgage?” read on below. We’ll tell you what this term means, how it works, and what the benefits are of using this type of financing in a real estate transaction.
What is a purchase money mortgage?
At its core, the purchase money mortgage definition is simple. This type of loan is an alternative to a traditional mortgage. In this case, rather than receiving the funds needed to purchase the home from a bank or lender, buyers who are using a purchase money loan enter into a contract with the sellers directly to buy the home.
Also known as “seller financing” or “owner financing,” this arrangement involves the buyers making a down payment to the sellers and making regular installment payments in exchange for equity in the home. It’s typically used in the event that the buyers cannot qualify for a traditional bank loan.
Types of purchase-money mortgages
Installment sale land contracts
Most purchase money mortgages are installment sale land contracts. These documents spell out details like the amount of the down payment, the interest rate, and the amount of the installment payments. They also cover details such as who will be responsible for the upkeep of the home and what happens in the event that the buyers decide to stop making payments.
Notably, installment sale land contracts do not pass legal title to the buyers right away. The buyers are only given the deed once they have made their final payment on the home.
Lease-purchase agreements are rarer, but they generally work similarly to a traditional lease, however, there the tenants may be required to buy the home at the end of the lease term. In this scenario, a portion of the rent that you pay during your lease term may be applied to the purchase price at the end of the lease term.
That said, the tenants may be required to get a smaller mortgage to account for the portion of the purchase price that wasn’t covered by their rent payments at the end of their lease term.
Benefits of a purchase-money mortgage
For the buyer
1. It affords you the opportunity to become a homeowner: If you are unable to get a traditional bank loan, your options for buying a home are likely going to be more limited. Purchase money loans offer a viable path to purchasing your own home.
2. There’s less red tape: Often, when you apply for a bank loan, you’re subject to certain requirements in terms of the down payment, interest rate, and loan term. Since purchasing loans are not held to the same standards, there is often more flexibility available.
3. You may save money on closing costs: Since there’s no mortgage company involved in an owner financing scenario, you won’t be required to pay any of their fees.
For the seller
1. It can be a source of passive income: In particular, sellers who are looking for an ongoing source of monthly income may benefit from this option because it gives you the chance to receive regular monthly payments.
2. That said, there’s still an option to receive a lump-sum payment: That said, if you’re not interested in receiving smaller monthly payments, it’s also possible to get paid in a lump-sum. We’ll get into more detail about the process later, but it’s possible to sell your purchase money mortgage note to an investor and receive payment right away.
3. There are often fewer contingency requirements: With bank loans, mortgage companies often impose certain contingency requirements – like getting a satisfactory appraisal or making certain repairs – that must be met in order to receive financing. However, with purchasing loans, you’re no longer subject to those requirements.
4. You may be able to close more quickly: Since the buyer doesn’t have to go through the underwriting process as they would with a traditional mortgage, you should be able to close on the home more quickly than you would normally
What to consider before entering into a purchase money mortgage
The terms of the contract
With a purchase loan, buyers and sellers need to work together to hammer out the terms of the contract and come up with an agreement that works for both parties. With that in mind, you’ll want to consider the following:
Loan term: The length of time that it will take the buyers to repay the loan
Down payment: A deposit that the buyers make to indicate their interest in purchasing the property
The interest rate: The rate that the sellers charge for the privilege of allowing you to pay for the loan over time
Balloon payment: A financing structure that some sellers use where they accept monthly payments for a set period of time and then the remainder of the loan becomes due as a lump sum
The structure of the contract
There are two separate ways you can structure your owner financing contract. The most common way is by drawing up a mortgage or purchase money deed of trust and a mortgage note. The mortgage note outlines the repayment terms for the loan and the mortgage or deed of trust holds the home up as collateral in the event that the buyer decides to default on the loan.
This is typically the method most preferred by buyers because it’s the most secure. In this case, the buyers will be put on the title and given a deed while the mortgage gets recorded in public records.
The other method is known as a “contract for deed” or “agreement for deed”. It’s structured in the same way as a mortgage and purchase money mortgage note, except that the seller remains on the deed until the loan is paid off in full.
For their part, sellers usually prefer this method because, since they remain on the title, the foreclosure process is often easier. It’s also a cheaper and easier method than the alternative.
What happens after selling a purchase money loan?
As discussed above, it’s possible to sell a purchase money loan. Many home sellers choose to go this route because, rather than waiting years to receive full repayment on the purchase money loan, it allows you to be paid for your asset in a lump sum. It also allows institutional investors and banks to recycle their capital without creating any new debt.
After buying your mortgage note, the note buyer will ultimately introduce the loan into the secondary mortgage market. In this case, whole loan acquisition firms like Amerinote Xchange will purchase the whole mortgage loan and service it through maturity.