What Is a Purchase Money Loan?

What Is a Purchase Money Loan?

If potential homebuyers can't qualify for a traditional mortgage loan from a bank, they can investigate a loan provided by the home's seller. This is called a purchase money loan.

Purchase money loans are often used by buyers who have trouble getting a traditional mortgage due to poor credit or by those who do not have enough cash for the down payment they need.

Alternate definition: The term "purchase money loan" is sometimes used for any loan used to buy a home or property. This is to distinguish loans used for buying a property from home equity loans or refinanced mortgages.

Alternate name: seller financing, seller's loan, owner financing, owner's loan, purchase-money mortgage, purchase-money loan

How a Purchase Money Loan Works

Purchase money loans usually take one of three forms:

• If the seller owns the home free and clear, the buyer pays a down payment to the seller. The rest of the cost of the home is financed by a purchase money loan from the seller. The seller decides the monthly payment and interest rate.
• If the seller still has a mortgage on the home, the buyer assumes responsibility for the seller's mortgage payments. The difference between the down payment and the mortgage amount that remains is the purchase money loan financed by the seller. The buyer pays the loan in payments equal to the monthly cost of the mortgage until they own the home.
• The buyer buys the home using a down payment and a bank loan but does not qualify for a large enough loan to cover the price of the house. The portion of the purchase price not covered by the down payment or the bank loan is the purchase money loan financed by the seller.

Sellers giving loans must comply with state laws regarding the length of the mortgage, licensing, and usury laws. What's more, purchase money loans often have higher interest rates than traditional loans because if the buyer has poor credit.

Purchase Money Loan vs. Hard Money Loan

A purchase money loan, under either definition, is based on the borrower's creditworthiness. The seller or other lender takes a risk that the buyer might not be able to repay the loan. If that happens, the property is foreclosed on and belongs to the lender.

Like a purchase money loan, a hard money loan is often used by buyers with poor credit. Still, it is usually done through a bank or other lender and involves using a property as collateral. The financing is based on the equity in the home and not always the buyer's credit report.

Types of Purchase Money Loans

The typical purchase money loan is made from the seller to the buyer. The terms are usually similar to a loan offered by a bank or other financial institution.

Several government programs offer what they refer to as "purchase money loans." In these cases, they are using the second definition of the term and describing special programs for getting a loan to purchase a home. The loan is obtained through a traditional lender and backed by the government program.

FHA Purchase Money Loans

The minimum down payment needed for buying a home with an FHA loan can be as low as 3.5% of the sales price. Some states offer secondary financing to help with the down payment and closing costs so a borrower can effectively put down zero. FHA loans are insured by the Federal Housing Administration, governed by the Department of Housing and Urban Development.

An investor cannot obtain an FHA loan. All FHA loans are granted to buyers who plan to live in the home.

VA Purchase Loans

A VA purchase loan is available to active and non-active military members and their spouses in some cases.

A VA loan is often offered for zero down payment, though a buyer can still pay a down payment of any amount. The government guarantees VA loans. Buyers don't have to pay certain fees in a VA transaction, and the loan can also be used for new builds or home improvements.