Purchase Money Loan: Definition And Types
When looking to buy a new home or property, very few individuals have sufficient cash on hand to make the purchase outright. Instead, the vast majority of home buyers apply for a mortgage with a bank or lending institution.
Unfortunately, qualifying for a mortgage is contingent upon several factors, and not all applicants will be approved. This can be incredibly frustrating for individuals looking to buy a home and may cause them to look for alternative options, one of which is a purchase money loan.
What Is A Purchase Money Loan?
A purchase loan is a form of borrowing offered to buyers by the seller directly. This differs from standard mortgages in which the borrower applies for financing from a bank or lending institution and uses the proceeds to buy a home or property.
This lending product is also referred to as a purchase-money mortgage, an owner’s loan, or a seller’s loan. It’s typically conducted in three ways.
- The seller doesn’t have a mortgage: If the seller doesn’t have a current mortgage on the home in question, the process is quite simple. The buyer will be required to come up with a down payment and then engage in monthly payments until the balance's remainder is paid off. The seller sets both the interest rate and term
- The seller has a mortgage: If the house that’s being purchased is still under mortgage, the buyer will agree to take over responsibility for the payments. It’s important to understand that the financing isn’t passed to the buyer. Thus, the financing is still technically in the seller's name, but the buyer agrees to make the repayments until the outstanding balance is paid off
- The buyer receives partial bank financing: Just because one doesn’t qualify for a conventional lending product doesn’t mean they won’t qualify for a loan of a lesser amount. In some cases, the buyer will have either savings or financing from which they can make a partial down payment. The amount that isn’t covered by the current borrowing and down payment is financed by the seller’s loan
Benefits Of Purchase Money Mortgages
This type of financing offers advantages to both the seller and the buyer.
- Advantages for the buyer: The most apparent benefit associated with owner financing for a buyer is that acceptance isn’t contingent upon one's credit history. Almost all people who opt for seller financing do so because they don’t qualify for conventional bank borrowing. Furthermore, purchase money agreements between a buyer and seller may offer the buyer a higher degree of flexibility regarding interest rates and repayment terms. In contrast, the bank's lending structure is strict and not subject to negotiation, whereas seller financing is more flexible
- Advantages for the seller: These are low-risk debts from the lender's perspective. Should the buyer default on their agreement, the seller will still maintain ownership of the home. Furthermore, sellers may even receive a higher overall price by offering their homes through owner financing. The reason behind this is simple; those who don’t qualify for financing but are aggressively pursuing homeownership may be willing to overpay if it means they can get a loan
Government Sponsored Purchase Money Loans
While it’s true that the majority of these financing offers are granted on behalf of the seller to the buyer, there are a few government programs that interested homebuyers should be familiar with.
- Veterans affairs purchase-money loans: Both active and inactive military personnel have the option to pursue a purchase-money mortgage through the VA. These lending products don’t require a downpayment, although many choose to make one anyway. This option isn’t subject to all the fees that standard loans carry. Furthermore, this financing is guaranteed by the government
- Federal Housing Administration purchase-money loans: An FHA purchase money loan requires a minimum down payment of 3.5% of the home's total sales price. It’s also subject to many of the same closing costs associated with traditional mortgages. This financing option is only available to the individual who’ll be occupying a property and thus, can’t be used for investment purposes
The Bottom Line
A purchase-money mortgage is an alternative form of financing available to those who don’t qualify for a traditional home loan. These types of lending products are made available to the buyer through the seller.
They require the buyer to make continual monthly payments until the agreed-upon balance is paid off in full.