What Is a Purchase Money Loan?

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When it comes time to purchase a new home, the vast majority of Americans will rely on some form of financing to ensure that they have the capital they need to complete the transaction. In a situation such as this, it is standard practice to apply for a traditional mortgage through a lender such as a bank.

However, qualifying for a mortgage is contingent on a variety of factors, many of which are directly related to the applicant's current financial health. If, for whatever reason, an applicant is deemed ineligible for a mortgage, they may need to seek out other forms of financing.

A purchase money loan, also referred to as a purchase money mortgage, is a convenient solution for this problem. With a purchase money loan, the buyer of the property receives their mortgage financing directly from the seller rather than a bank.

TL;DR (Too Long; Didn't Read)

A purchase money loan is an alternative form of home financing that is often used by individuals who are unable to qualify for a traditional mortgage. Although a purchase money loan does provide a gateway to homeownership for many individuals, the specific interest rates and borrowing terms attached to this borrowing tool may not be the most favorable.

Introducing Purchase Money Loans

As mentioned previously, a purchase money loan is a form of financing provided directly by the seller of a property rather than through a bank. There are likely two reasons why a purchase money loan would be utilized instead of a traditional mortgage. The most common reason that a property buyer would request a purchase money loan is if they were unable to qualify for favorable terms as part of a traditional mortgage application. In a situation such as this, the only viable method for obtaining the funds needed to purchase the property could be a purchase money loan.

Yet another common reason for requesting this particular mortgage platform is if the buyer of a property is taking control over the current owner's mortgage rather than acquiring an entirely new leading platform. In a situation such as this, the amount of money that has already been paid into the mortgage is subtracted from the total purchase price in order to determine exactly how much funding will be required to complete the remaining payments on the loan.

Initiating Purchase Money Financing

In order to successfully acquire a purchase money loan, the buyer will likely have to provide some form of down payment, although this is often a point of discussion and negotiation between buyer and seller. In some situations, sellers may allow buyers to pay the down payment in installments in order to ensure that the initial fund requirement is met on more comfortable terms.

Because a banking institution is not involved in the mortgage creation process, the closing costs for a purchase money loan are often significantly less than those attached to traditional mortgages. That being said, a purchase money loan may not always compare favorably to traditional mortgages when it comes to affordability.

Given the fact that these loans are often the last resort for many home buyers, the seller of the property can dictate the terms of the purchase money loan as they see fit, which may mean that interest rates on the funds are higher than those attached to more conventional home loans.

The property seller may also choose to raise the price of the home when dealing with an individual who cannot rely on traditional mortgages. This is due in large part to the fact that the seller is aware of the fact that the pool of available homes for sale with purchase money loan financing is quite small. Consequently, home buyers relying on this form of financing have significantly less bargaining power than individuals using traditional mortgages.

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About the Author

Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community. Ryan's work has been featured at Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.

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