A Complete Guide to Purchase Money Mortgages: Pros, Cons & Types Explained
What Is a Purchase Money Mortgage?
A purchase money mortgage, also called seller financing, is a real estate financing method where the homebuyer borrows directly from the seller instead of using a traditional mortgage lender.
This option is typically considered when buyers:
Have low credit scores
Can’t meet conventional loan standards
Want to avoid the lengthy underwriting process from banks
The seller becomes the lender and sets the terms—such as down payment, interest rate, and repayment schedule—usually secured by a deed of trust or mortgage. If the buyer defaults, the seller has the right to foreclose and reclaim the home.
How Does a Purchase Money Mortgage Work?
Here’s a step-by-step breakdown:
Negotiation: Buyer and seller agree on the price, loan amount, down payment, and loan terms.
Legal Documentation: A promissory note and deed of trust are created and recorded, outlining the agreement.
Ownership Transfer: The buyer gets the deed and begins making monthly payments directly to the seller.
Final Payment: After a specified term, often 3–5 years, the buyer must pay a balloon payment or refinance.
🏠 Example of a Purchase Money Mortgage
Let’s say Jordan wants to buy a $240,000 home but can’t qualify for a traditional loan due to a 610 credit score. The seller agrees to finance the sale if Jordan can put down $60,000.
Terms:
Loan: $180,000
Interest rate: 8%
Amortized over 25 years
5-year balloon term
Jordan pays about $1,387/month for 60 months, after which a balloon payment of around $159,000 is due—unless Jordan refinances or sells the home.
✅ Benefits for Buyers
1. Easier Approval
Buyers with credit challenges or high debt-to-income ratios may still qualify since the seller sets their own criteria.
2. Faster Closing
Without the traditional mortgage process, you could close in days instead of weeks.
3. Flexible Down Payments
The seller can negotiate any down payment, including alternatives like personal loans or gifted funds.
4. Lower Closing Costs
You avoid lender fees, loan origination charges, and appraisal requirements, potentially saving thousands.
❌ Drawbacks for Buyers
1. Higher Interest Rates
Sellers typically charge more than banks to compensate for added risk.
2. Balloon Payments
Most seller-financed loans require a large lump-sum payment after a short term (e.g. 5 years), which can create refinancing pressure.
3. No Consumer Protections
Seller financing isn’t regulated the same way as traditional mortgages. You need a real estate attorney to review your contract.
✅ Benefits for Sellers
1. Potential for Higher Price
Sellers offering financing often command a premium for flexibility.
2. Installment Tax Benefits
Instead of a large capital gains tax bill, sellers may qualify for installment sale treatment, spreading taxes over several years.
3. Passive Income Stream
Monthly mortgage payments provide steady income over time.
❌ Drawbacks for Sellers
1. Buyer Default Risk
There’s a higher chance the buyer could miss payments, especially if their credit was already a concern.
2. Delayed Payout
Unlike traditional sales, sellers don’t get the full purchase price upfront unless the buyer refinances or sells quickly.
📘 Types of Purchase Money Mortgages
Understanding the different formats can help you choose the best route if you're considering this financing strategy.
1. Land Contract (Contract for Deed)
Seller retains ownership until the loan is paid in full.
Buyer gets possession and builds equity through monthly payments.
Commonly includes a balloon payment after a short term.
📌 Tip: These require no bank involvement, but buyers have fewer protections since title doesn't transfer until full payment.
2. Lease-Purchase Agreement
Buyer leases the home for a set period (e.g. 1–3 years).
A portion of rent goes toward the eventual down payment.
Buyer must purchase the home at the end of the lease.
📌 Often used by buyers who need time to improve credit or save for a larger down payment.
3. Lease-Option Agreement
Similar to lease-purchase, but gives the buyer the option—not obligation—to purchase later.
Often includes a non-refundable option fee.
Useful when you're unsure about committing long-term.
4. Assumable Mortgage
Buyer takes over the seller’s existing mortgage and payments.
Must be approved by the current lender.
Common with FHA, VA, or USDA loans.
📌 Ideal if the seller’s interest rate is significantly lower than today’s rates.
🧠 Should You Consider a Purchase Money Mortgage?
Purchase money mortgages are best for buyers who:
Can’t qualify for traditional financing
Have access to a sizable down payment
Expect to refinance or sell within a few years
Are working with a knowledgeable real estate attorney
For sellers, it’s a powerful tool to move a property faster, at a higher price, while generating income—but it’s not without risk.
📝 Final Thoughts
A purchase money mortgage may feel unconventional, but in today’s tight lending environment and with rising home prices, it could be the bridge to homeownership many buyers need.
Just make sure you:
Consult with an attorney
Understand the balloon payment timeline
Build a plan for eventual refinancing or full repayment
With the right structure, seller financing can be a win-win for both parties.
