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Last updated: June 15, 2022
Purchasing a home is a huge financial commitment. It can be tricky to qualify for a mortgage from a traditional lender if you haven’t saved enough for a down payment, or if your credit score is too low.
Programs to help you pay for a home are offered by both the government and some banks, but they may still have criteria such as credit requirements and income limits. Fortunately, you have other options.
If you don’t qualify for mortgage financing or are simply curious about your options, here are four alternatives to getting a traditional mortgage.
1. Pay cash
Perhaps the most obvious alternative to buying a house with a mortgage is buying one in cash. Still, just because it’s obvious doesn't mean it is a realistic option for most people. With a cost of living that continues to rise, it can be challenging to save enough money for a down payment, let alone enough to pay for a house in full.
However, if you find yourself in one or more of the following situations, paying cash for a home may be an option:
- You’ve saved a lot of money
- You’re buying in an affordable area
- You’ve inherited a large sum of money
Benefits to paying cash for a home
Of course, there are benefits to paying cash for a home. For example, making a cash purchase can save you headaches and money in the long run. More specifically, you may experience some of the following benefits by buying a home outright:
- Not paying interest on a mortgage loan
- Saving on some closing costs, such as a property evaluation fee or mortgage default insurance
- Not having monthly mortgage payments
- Enjoying being debt-free
- Closing faster on a sale
- Skipping an appraisal (unlike with mortgages)
A cash purchase also has advantages for the seller, particularly if there is a bidding war and they want to make a quick sale. A cash offer means they don’t need to worry about you backing out of the sale because you are denied financing.
Drawbacks to paying cash for a home
There are some key downsides to paying cash for a home. For example, tying up your money in a home and not having enough left in your bank account could be an issue if you encounter financial troubles down the road.
Suppose you get laid off from your job and you lose your income. If you’ve invested all your savings into a home, you may not have enough of a financial cushion. Alternatively, if your home needs repairs and all your money is tied up in the equity, you may have a tough time covering the resulting costs.
In addition to keeping money readily available for emergencies and other things, some people argue that there are better ways to use and invest money.
Even if you can pay cash for a home, you could still get a mortgage and invest your money for retirement. By investing the money in a diverse portfolio, your rate of return may exceed the interest on your mortgage, leaving you with more money. Deciding whether you should pay cash for a home or get a mortgage and invest your money elsewhere depends on your financial circumstances, the mortgage’s interest rate, your age, and more.
2. Get a private mortgage loan
Consider a more unconventional loan if your credit score is too low to qualify for a traditional mortgage. You may have better luck securing a mortgage loan from a private lender. Private lenders are not affiliated with a bank and can either be private lending companies or individuals.
Generally, private lending companies are less risk-averse than banks. Therefore, they may charge you a higher interest rate than a traditional lender (i.e., a bank) to account for the higher risk of lending to you.
Often, the most attractive private lending option is to borrow from a family member or friend who can afford to lend you the money, which is sometimes referred to as peer-to-peer lending. Similarly to paying for a home in cash, borrowing money from someone you know is not an option for everyone. Still, if you find yourself in a situation where a family member or friend is willing to loan you the money, it might be a worthwhile option.
Benefits of peer-to-peer private loans
Peer-to-peer private loans can benefit both you and your lender in the following ways:
- You can negotiate more flexible payment terms
- Your lender may charge you a lower interest rate because they are trying to help you out
- Your lender could earn more interest off your loan than with other types of investments
What documents should you use for private mortgage loans?
Even if you have a close relationship with the lender and trust each other, it’s still important to consider this arrangement a business deal and protect yourselves with a written contract. You should use a Loan Agreement or Promissory Note to document the terms of the loan, including payment frequency, payment amounts, and how long you have to repay the money.
Depending on your jurisdiction, you or your lender should also draw up a Mortgage Agreement or Deed of Trust, which will put a lien on the property to secure the loan. The lien gives the lender the right to foreclose on the property if you fail to repay them.
Once you repay the loan, the lien is removed with a Satisfaction of Mortgage or Deed of Reconveyance.
3. Use owner financing
Occasionally, a seller may be willing to sell to you directly and let you pay them in installments. This type of arrangement is known as owner financing and means that the seller finances your purchase. Under owner financing, you make monthly mortgage payments to the seller rather than a bank.
If you find a seller who is willing to finance the sale for you, they will usually keep the property title under their name until you fully pay them back. Once you pay them back equal to the agreed-upon sale price, they legally transfer the property to you. While you pay them in installments, you have the immediate right to possession of the property.
Finding a seller ready to enter into this type of arrangement can be challenging, but those who have paid off their mortgage in full and don’t need the cash from the sale immediately may be more willing. Owner financing can benefit both you and a seller because it can eliminate some banking costs.
The most common instances of owner financing appear between family members and friends. Generally, this type of unconventional sale requires some level of familiarity.
Documents for owner financing
Any real estate transactions should be documented in writing, so the seller and buyer should either create a Real Estate Purchase Agreement or Land Contract to facilitate the sale and outline the payment details. A Land Contract allows you to provide more context and explanation about an owner financing arrangement.
In many cases, the seller will wait to transfer the property title until you have made your final payment, at which point they can use a Warranty Deed or Quitclaim Deed to transfer legal ownership.
4. Rent to own
Renting to own is an arrangement between you and a seller in which you rent their for-sale property before buying it for a predetermined price. Renting to own can be a good alternative if you cannot save for a down payment or don’t qualify for mortgage financing due to a low credit score.
Depending on the seller’s expectations, you may pay a fee for the exclusive right to buy the property at the end of the lease.
In a rent-to-own situation, you act as a tenant, living in the home and paying rent, and the seller acts as your landlord. Renting to own may occur the most in the following situations:
- When someone is having difficulty selling their home, they may list it as a rental with a rent-to-own option.
- When someone has a long-term tenant who is interested in buying the rental property, they may establish a rent-to-own arrangement.
- When someone wants to sell their home to a specific buyer, such as a friend or family member, and the buyer cannot afford it, they may suggest a rent-to-own arrangement.
Depending on the seller’s preference, they may set aside a portion of your rent payment for a future down payment. Renting to own can allow you to buy time while you improve your credit score or save more for a down payment.
Keep in mind that renting to own does not necessarily eliminate having to get a loan. If you rent to own for one year, the seller may require full payment at the end of said year. To pay them, you may have to secure some type of financing. If you are a first-time buyer, a Federal Housing Administration (FHA) loan may be a good choice because the down payment and credit score requirements are low.
Types of rent-to-own arrangements
If you sign a lease-purchase contract, you are legally obligated to purchase the property at the end of your lease. A lease-purchase agreement is also known as a rent-purchase agreement.
Lease-purchase agreements give you no flexibility. If you sign one, you must buy the property at the end of your lease term. You must understand this commitment before committing to a lease-purchase agreement.
Option to purchase
If you have the option to purchase, you have the right to buy the property at the end of your lease, but you are not contractually obligated. The option to purchase can be added to a Residential Lease Agreement or outlined in a separate option to purchase agreement.
If your landlord gives you the option to purchase, the two of you will have to determine the following details:
- Will you predetermine a purchase price or will it be an average of multiple market appraisals?
- Will you pay a non-refundable option fee for including the option to purchase in your lease?
- Will you pay a refundable option deposit towards the purchase?
- When will your option to purchase expire?
- How many days will you have to complete the purchase after exercising the option to purchase?
Benefits of renting to own
- You can work to improve your credit score as well as build equity in the home
- You get to experience homeownership and decide whether it is a good fit for your lifestyle
- You also have the chance to test out the home and neighborhood before committing to a longer-term arrangement
- You can buy the home for the price you settled on when you created the agreement, regardless of whether real estate prices have gone up
- You can opt-out of the purchase at the end of the lease if you have the option to purchase
Consider all your options
There is no correct way to buy or finance a home. Sure, most people use mortgages to buy their homes, but that does not mean that it is the only path towards homeownership. Everyone’s circumstances are different, so you have to take advantage of the opportunities that are provided to you.
If you have the choice to pay cash, get a private loan, obtain owner financing, or rent-to-own, you should definitely consider your options. These unconventional ways of buying a home might be best for you.