What Is a Purchase Money Loan?
Definition & Examples of Purchase Money Loan
A purchase money loan is a loan issued to the buyer of a home by the seller. It is also called seller financing or owner financing.
Learn why a buyer might need a purchase money loan and how it works.
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 qualifying for a traditional mortgage due to poor credit, or by those who do not have enough cash available for the down payment they need.
If you are offered seller financing, you should still have an independent appraisal done to ensure that you are not overpaying or taking out a larger loan than the property is worth.
Alternate definition: The term "purchase money loan" is sometimes used for any mortgage used to buy a home or property. This is to distinguish loans used for purchasing 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 does not have a mortgage, the buyer pays a down payment and the remaining cost of the home is financed by a purchase money loan from the seller. The seller establishes 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 remaining mortgage amount is the purchase money loan financed by the seller. The buyer pays the loan in installments equal to the monthly cost of the mortgage until they own the property.
- The buyer purchases the home using a down payment and a traditional 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.
If you are using a traditional loan, be sure to tell your lender about any additional financing you have obtained, including seller financing.
Sellers offering loans must comply with state laws regarding the length of the mortgage, licensing, and usury laws. However, purchase money loans often have higher interest rates than traditional loans because of the borrower's poor credit.
Purchase Money Loan vs. Hard Money Loan
|Purchase Money Loan||Hard Money Loan|
|Financed through seller||Financed through a traditional lender|
|Terms based on seller's existing mortgage or borrower's creditworthiness||Terms based on borrower's property as collateral|
|Approval can be slow||Approval usually quicker|
|Often used by borrowers who have trouble qualifying for a traditional home loan||Often used by borrowers who have trouble qualifying for a traditional home 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 borrower 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 borrowers with poor credit. However, it is usually done through a bank or other traditional lender and involves using a property as collateral. The financing is based on the equity in the property and not necessarily the borrower's creditworthiness.
Types of Purchase Money Loans
The typical purchase money loan is made from the seller to the buyer, using similar terms to a loan offered by a bank or other financial institution.
However, several government programs offer what they refer to as "purchase money loans." In these instances, they are using the second definition of the term and describing specialized programs for obtaining 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 requirement 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 borrowers who will occupy the property.
VA Purchase Loans
A VA (Veterans Affairs) purchase loan is available to active and non-active military and their spouses under certain circumstances.
A VA loan is typically zero down, though a borrower can put down any amount. The government guarantees VA loans. Borrowers are restricted from paying certain fees in a VA transaction, and the loan can also be used for new construction or certain home improvements.
- A purchase money loan is issued to the buyer of a home by the seller. It is also called seller financing or owner financing.
- Purchase money loans are often used by buyers who have trouble qualifying for a traditional mortgage due to poor credit.
- Purchase money loans can be structured like traditional loans or involve the buyer taking over the seller's mortgage.
- They can also be used by buyers who receive a traditional loan that was not large enough to cover the difference between the purchase price and the down payment.