Real estate or mortgage financing must take an alternative financing path when institutional lenders, such as those described earlier, will not loan on a property, or the buyers face bad credit issues.
Let’s briefly review some of the more commonly available alternative financing mortgage methods to institutional lenders.
Purchase Money Mortgage
A purchase money mortgage is when a seller is willing to accept part of the purchase price owed him/her in the form of the buyer’s promissory note accompanied by a mortgage of deed of trust, it is also called purchase money deed of trust. This allows the buyer to substitute a promissory note for cash and the seller is said to be “taking back paper.” Purchase money financing is popular for land sales (where lenders rarely loan), on property where an existing mortgage is being assumed by the buyer, and on property where the seller prefers to receive his money spread out over a period of time, with interest, instead of lump-sum cash. For example, a retired couple moves out of a large home into a smaller one. The large home is worth $120,000, and they owe $20,000. If they need only $60,000 to make their move, they might be more that happy to take $60,000 down, let the buyer assume the existing mortgage and accept the remaining $40,000 as $400 per month payments at current interest rates. Alternatively, the buyer and seller can agree to structure the $40,000 as a VRM, RRM, ARM, GPM, partially amortized loan or interest-only term loan.
If the seller receives the sales price spread out over two or more years, the seller can use the installment reporting method for calculating income taxes. Being able to spread out the taxes on a gain is a major incentive to use seller financing, especially for investment property.
The seller should be aware, however, that he may not be able to convert his “paper” to cash without a long wait or without having to sell it at a substantial discount to an investor. Additionally, the seller is responsible for servicing the loan and is subject to losses due to default and foreclosure. Nonetheless, in a tight money market a purchase money mortgage, or one of the real estate financing alternatives discussed next, may be the only way he will be able to sell.
Alternative Financing To Wraparound