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Alternative Financing Methods
There are many reasons why people can't qualify for a
new mortgage: not having enough income that can be verified (for
example, a self-employed person); not having enough income to meet the
qualifying ratios for a new mortgage; not having enough cash available
to meet the bank's requirements for down payment and closing costs; or
not having good enough credit to satisfy a bank's underwriting
guidelines. There are a number of solutions if you still want to buy a
home. Depending on your resources (the three C's of home buying: Cash,
Cash flow and Credit), you can consider buying a home:
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That has a freely assumable mortgage on it;
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That has a seller that is willing to help finance
your purchase (known as Seller finance or owner take back a
mortgage);
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That has an owner willing to let you rent to own
(also called lease/option or lease/purchase);
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That involves the use of seller concessions or
contributions toward closing costs; or
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That involves higher risk mortgages (known as B, C,
D Credit Loans).
If you have a substantial amount of cash to work with
then the lack of credit and/or income can usually be overcome. If you
have a small amount of cash to work with but have very strong credit and
cash flow (income), then the lack of cash can usually be overcome. If
you have a moderate amount of cash to work with and reasonable credit
and cash flow, then you should still be able to get a mortgage.
These kind of situations must be handled on a case by
case basis. One key is knowing which lender or mortgage broker to
approach. Many have their specialties depending on your situation. You
need to find the specific lender who can best help you given your
individual situation.
Freely Assumable Mortgages...
There are properties for sale today that have "freely"
or "fully" assumable mortgages already on them. These are mainly FHA
mortgages that had the appraisal accepted by FHA prior to December
15,1989 or VA mortgages that closed prior to March 1,1988 and which
haven't been refinanced. If they were refinanced, the option of having
the mortgage freely assumed is lost. Some conventional mortgages are
also freely assumable. "Freely" or "fully" assumable means that the bank
won't require you to qualify for the loan. There is no verification of
your income, assets, employment or credit.
Some loans are assumable, but only with the lender's
approval, meaning you would be required to fully qualify for them. This
would include VA and FHA loans after the above dates or which have been
refinanced. Care must be taken to be sure that the loan is in fact
"freely" or "fully" assumable before spending any time trying to
negotiate on a property, if in fact you need to use such a financing
technique.
If you are able to qualify for a mortgage, sometimes
buying a property by assuming a mortgage, subject to bank approval,
still makes sense. For example, the seller may be willing to let the
property go for the balance of the mortgage, thus reducing the amount of
cash you need to bring to closing. Perhaps the seller will allow you to
take over the "escrow" account for taxes and insurance without
reimbursing them, thus reducing the amount of cash you need at closing.
Perhaps the seller will consider taking back a second mortgage for all
or part of the equity and closing costs. The drawback? There aren't many
homes
Seller Finance...
A seller might help finance part of your down payment
and closing costs with a second mortgage. This works well with freely
assumable mortgages. However, most conventional and government loan
programs prohibit second mortgages. An exception to this would be
non-conventional, also referred to as "non-conforming" first mortgage
loans with 65% to 75% loan to value ratios. In these cases the lender
may not have a problem with the seller or someone else helping finance
the equity by means of a second mortgage.
A seller might also help finance your purchase with a
first mortgage if they own the property free and clear (with no
mortgage) or with a small mortgage that they can pay off from other
assets or from cash that you give them. The seller may not have an
immediate use for cash and therefore would prefer to finance your
purchase of their property to earn a higher interest rate on their money
than would otherwise be available to them. It also makes it easier for
them to sell their house because more people would be able to buy it.
Because the seller will be acting as the bank the seller
will also want to review your credit, references, income etc. Sellers
are more flexible with respect to credit guidelines and credit problems
than a bank would be.
With seller held first mortgages, generally there is no
escrow account set up for real estate taxes and fire insurance. You will
be required to pay these on your own when they come due. You must take
that into consideration when determining if you can afford the home. If
you don't pay the real estate taxes or fire insurance when due, that
would be a default in the mortgage and the seller could foreclose on the
property - and you would lose your equity.
Lease Options - Lease Purchases...
A lease option is a method of buying in which the buyer
has "an option to purchase" at a particular price and on particular
terms within some fixed time period. A lease purchase is "a firm
commitment to purchase" a property by a buyer at a particular price and
on particular terms within some fixed time period. A lease purchase may
be contingent on the buyer being able to get a mortgage, but otherwise
the buyer is obligated to complete the purchase or lose their deposit. A
lease purchase really is a regular purchase with a delayed closing.
Sometimes these methods are also called "rent to own".
The terms for these vary greatly depending on the needs
and resources of the seller and you, the buyer. However, a typical lease
option or lease purchase works as follows: You lease a home for one year
and pay, say, $850 per month. You have the option to purchase the home
for, say, $75,000 anytime during the one-year period. If you do buy the
home, the seller will give you credit at closing for a portion of your
rent payments, say $150 per month (totaling $1800 in this example). You
would also get credit for any security deposit, say $850 (one months'
rent). For an FHA loan, your total down payment and closing costs would
run about $7000 with a $75,000 purchase. The credits of $2650 ($1800 +
$850) would leave you with $4350 as an amount you would have to save up
over the 12 months in order to qualify for the loan.
Lease options or lease purchases are very beneficial for
a buyer who can't qualify for a mortgage now, but who can qualify within
one year. This may involve needing some time in which to clean up credit
and/or save additional money for down payment and closing costs. They
are a waste of time and money, however, for a buyer who won't be able to
get a mortgage and close within a year or so. Most sellers also won't
consider this method of purchase so you are limited with respect to
possible homes to purchase.
Seller and Lender Concessions...
If the only thing holding up a buyer's purchase is lack
of funds to close, most mortgage programs allow for seller
contributions. This allows the buyer to increase the purchase price and
mortgage slightly to obtain the cash needed. Here is an example: Say a
seller would initially agree to a price of $70,000. Buyer is short $2500
for down payment and closing costs. Buyer and seller then agree to a
$72,500 purchase price and for seller to give buyer credit at closing
for $2500 to be used towards buyer's closing costs, prepaids and/or
adjustments. Result, the buyer is able to qualify for the mortgage, the
seller gets their $70,000 and the deal closes.
Two cautions: first, the property has to appraise for
the higher price and second, because conventional loans, VA and FHA
loans all have differing requirements, care must be taken to structure
the contributions properly depending on which loan is involved to avoid
problems with qualifying or with closing.
Another method of getting cash for closing costs is
through the use of "lender" concessions. You agree to pay a higher
interest rate then you otherwise would be required to do. In return the
lender supplies additional money at closing to pay some of your closing
costs. For example, say the rate you would have gotten is 7.5%. The
lender charges you 8.25% instead and agrees to give you $1500 at closing
to help with your closing costs. Your monthly payment would be slightly
higher, but it does allow you to qualify for a loan and purchase a home.
Many loan programs also allow for gifts from family
members towards closing costs. So if you have a parent or sibling who is
willing to help you out, this may be another way to help with the cash
needed for down payment and closing costs.
Higher Risk Mortgages...
B, C, D Credit Loans: Even if a buyer has a recent
foreclosure, bankruptcy, late payments and/or other credit problems
there are lenders who will still grant a mortgage. Due to the higher
risk these loans generally require higher down payments then regular "A"
credit type loans. These down payments usually will range from 15% to
30% of purchase price. Normal "A" credit down payments run 3% to 10%.
Interest rates will be higher also. "B, C, D" credit will usually
require interest rates of 10% to 14% and higher. Normal "A" credit rates
run 6.5% to 8% currently. Also, closing costs will be higher and range
from $2000 to $5000 additional over "A" credit deals.
Nonetheless, it does give certain buyers, in particular
those with extra cash available, the opportunity to own now,
re-establish good credit and then refinance to normal interest rates in
two to three years. However, great care needs to be exercised with this
method. There are many lenders who can easily take advantage of you and
over charge you. Sometimes the credit issues that you believe may cause
a problem and that a B, C, D credit lender say warrant them charging you
more, actually aren't that bad.
Perhaps it would be better to attempt to clean up your
credit first, delay your home buying by 6 months and then reapply to
obtain a mortgage with better terms. Your best bet is to follow our
suggestions with respect to obtaining your credit profiles first,
cleaning up any inaccuracies, negotiating and clearing off any
collections or judgments and then approaching lenders with your cleaned
up report. This will give you a better opportunity to get a lower down
payment, lower interest rate and lower closing cost mortgage.
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