Definitions for purchase money mortgages that sellers should know

What is a purchase money mortgage?

There are two definitions for purchase money mortgages.

The first is any mortgage used to purchase the property. This is important, since some states do not allow deficiency judgments on purchase money mortgages.
The second, and more common definition, is a mortgage given to the seller as part of the purchase price.

With all the programs now being offered, a person without a 20% down payment can usually still find a mortgage that fits his or her needs with PMI, LPMI, or a piggyback loan. However, sometimes you might be able to secure a purchase money mortgage from the seller. A seller may be willing to take a mortgage for some portion of the purchase price. There are many reasons why a seller may consider this. When mortgage rates were 20%, some sellers thought offering a 15% mortgage was a good investment. It was even recommended by some financial advisors for people retiring and moving to smaller, less costly homes. Another consideration is that a buyer would not have to qualify for a 20% loan from the bank. The seller could accept anyone he or she wanted, allowing the sale to go forward.

If you are in a situation in which seller financing is offered, remember that there are no guidelines. As long as the transaction does not violate any laws, whatever you agree to is binding. Always have a knowledgeable person review all documents before you sign anything. Be sure that you know the terms of the loan and prepayment penalties, if any.

What should a seller know about purchase money mortgages?

On the other side of the seller-financed loan is the seller, and there are things a seller should know about taking a purchase money mortgage. If you are selling your home and a potential buyer asks if you will take back paper or carry paper, you are being asked to take a mortgage for all or part of the purchase price. What are the ramifications? Purchase money mortgages almost always have a higher interest rate than other mortgage loans. As the seller, you will probably get a better return than you could get elsewhere on your money. The reason you can charge a higher rate of interest is that you are giving a high-risk loan. A buyer is willing to pay higher interest for one of two reasons.

He or she cannot get a loan from the usual sources, possibly because of poor credit.
The buyer does not have enough money for a sufficient down payment.

Either of these reasons creates risk. Sellers having difficulty getting a buyer may be willing to accept a purchase money mortgage, especially if the potential buyer has good credit and is simply short of cash. This could easily be the situation with a first-time buyer. If you are interested in getting this type of mortgage, there are certain precautions you must take.

One precaution you can take concerns the first mortgage. Many types of loans do not allow the buyer to borrow the down payment. If the first lender finds out that the down payment was financed, it has the right to foreclose. You must be sure that the lender your buyer is using allows your purchase money mortgage.

Consult with an attorney before financing the total purchase price, and have your attorney either draw the note and mortgage or review the note and mortgage you plan to use. Have the borrower fill out a mortgage application giving you the right to perform a credit check and employment background check. Also, get the buyer's tax returns for the past three years. Be sure that your title insurance policy protects you against forgeries - it usually does - especially if you are going to be the only mortgagee.

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