What is a Purchase Money Mortgage? A Risky Money Move

Buying a home with bad credit can be challenging, especially when the housing competition is so fierce.  

The recent inventory shortage is pushing home prices up, making it more difficult for people with bad credit to secure large loan amounts.  

There is an option that could help close the gap. It means skipping the bank altogether or supplementing a bank loan with a purchase money mortgage. 

But just because it’s an option doesn’t mean it’s a good one. Purchase money mortgages come with huge risks for the seller and higher prices for the buyer. 

Here’s what you need to know.

What Is a Purchase Money Mortgage and How Does it Work?

Purchase money loans, also known as seller financing or owner financing, allow buyers to avoid banks altogether by having the seller step in as the lender. It’s used mainly for buyers who might have difficulty qualifying for a bank loan. 

This is different from a traditional home sale with a bank. With a bank-lender sale, funds from the buyer’s down payment and loan are used to pay off the seller’s existing mortgage and closing costs. The sellers keep any leftover funds as profit. 

With a purchase money mortgage, though, the bank is not involved. Instead, the seller takes the place of the bank as the lender. There are many ways this could be structured, but in essence, the buyer of a home makes payments directly to the seller as if they were a bank. The buyer would sign a loan agreement with the seller outlining the loan terms, such as the interest rate, loan amount, and the amount of the monthly payments. 

Types of Purchase Money Mortgage Situations

Purchase money mortgages can be structured in a number of ways. 

Bank loan with a money mortgage. A purchase money mortgage can be used in addition to a bank loan if the buyer is not able to get a loan large enough to cover the home costs. For example, a buyer can purchase a $300,000 house with a $200,000 bank loan, $50,000 in upfront cash, and a $50,000 purchase money mortgage.

Land contract. The seller and buyer agree on the amount of the down payment, home price, payment frequency, and interest rate. The buyer of the home does not gain full legal ownership of the property until the last payment on the loan has been made.

Assumable mortgages with a purchase money mortgage. With the approval of the seller’s mortgage lender, the buyer takes over the seller’s existing mortgage terms. The difference between the balance on the assumed mortgage and the home’s sale price could be financed through a purchase money mortgage. For example, a buyer assumes a seller’s $250,000 mortgage, payment terms, and interest rate. But the home is listed for $300,000. The buyer could use a $50,000 purchase money mortgage to cover the rest. 

Purchase Money Mortgage Pros and Cons for Buyers 

Since compliance regulations require banks to adhere to strict lending requirements, there are a number of factors that could make a person or a property ineligible for financing. “Purchase money loans offer buyers easy financing [because there are] no restrictions on your debt ratio, credit score, or down payment,” says Huy Nguyen, a former lending supervisor at Wescom Credit Union in California. 

While seller-financing may be easier for a buyer to purchase a home, that doesn’t mean it comes without downsides. If you are a homebuyer with credit issues and can’t qualify for a traditional mortgage loan, you’ll likely pay a higher overall price for the house with a purchase money mortgage. This accounts for the risk the owner is now assuming that the bank normally would take on. The home will likely be listed for a higher price, and the interest rate will also be higher. 

Here are a few other pros and…