July 26, 2023
Not prepared to buy your home today? Struggling to secure financing? There’s more than one way to finance your purchase and we’ve identified seven of the best.
7 Alternatives to a Traditional Mortgage
Not prepared to buy your home today? Struggling to secure financing? There’s more than one way to finance your purchase and we’ve identified seven of the best.
Life happens, and sometimes you may be caught unprepared for a home purchase. Maybe you’ve experienced a life change like a marriage, divorce, or the birth of a child. Maybe you’re relocating to a market that’s far more expensive than your current one. Maybe your growing family needs more space both indoors and out. If you’re not able to secure traditional financing for the home you have in mind, check out these alternatives to a traditional mortgage and determine which ones work best for your individual financial situation.
For many people, a traditional mortgage offers a fixed rate and amortization over either 15 or 30 years. They may be conventional or government-backed like VA, FHA, or USDA home loans. Down payments can range from $0 for VA or USDA to 3.5 percent for FHA or conventional down payments ranging from a low of 3 percent to a high of 20 percent or more.
The advantage of a conventional mortgage lies in its predictability. Because you’re locking in your interest rate, you know how much your payment will be each month. That allows you to budget more effectively and stay on track for your mortgage payoff date.
Whether you’re looking for more favorable terms or simply don’t qualify for a more standard mortgage product, there are plenty of alternatives to the traditional mortgage for you to consider.
What it is: A mortgage offering an adjustable rate but with fixed monthly payments that do not change with interest rate adjustments.
Risks: If interest rates rise, you could end up in a negative amortization scenario where your payments are not sufficient to keep up with the interest you owe. This makes building equity much slower and more unpredictable.
Benefits: Predictability and affordability are two benefits of this loan since you always know what your payment will be, similar to a fixed-rate mortgage.
What it is: Instead of financing the amount you’re borrowing to purchase the home, an interest-only mortgage allows you to finance the interest alone for the first several years of the loan term, generally up to 10 years. After that, amortization of the principal kicks in and increases the loan amount.
Risks: If the buyers’ financial situation does not improve during the interest-only part of the loan, they may find themselves unable to continue with the purchase long-term.
Benefits: For those who are building a career or seeking to buy more home than they could otherwise afford with a more traditional loan product, an interest-only mortgage may be a solid option.
What it is: Similar to an interest-only loan, borrowers pay a reduced sum for a fixed term at the front of the mortgage, with the balance balloon due at the end of that term. Otherwise, they will need to refinance into a traditional mortgage.
Risks: Buyers who are unable to save up the money for the balloon payment or who are unable to secure additional financing may find themselves facing foreclosure.
Benefits: The low monthly payment could be a good option for those whose financial prospects are expected to improve throughout the loan term.
What it is: An agreement between the buyer and seller where the buyer rents the home for a period of time during which the seller puts aside a portion of the rent as a down payment. At the end of the lease term, the buyer secures financing and uses their down payment savings to purchase the home or, if they choose, they may decide to move on to another house.
Risks: For the seller, there’s the risk that the buyer may not choose to purchase the home. However, during the lease term, they will have received rental payments and are then able to sell the property, allowing them to monetize it twice.
Benefits: Buyers are able to see if they truly love the home before they go all-in with a purchase. Once they reach the end of the lease term, they then have the option to buy built-in.
What it is: A homeowner who does not immediately need the proceeds from their home sale may choose to finance the property for the buyer.
Risks: Buyers generally pay higher interest rates than they would with a commercial mortgage. In addition, owner-financed properties are difficult to find and secure. For the seller, the risk is that the buyer may damage the property or fail to make on-time payments, requiring an expensive and time-consuming eviction process.
Benefits: For the buyer, speed and convenience are the major benefits, especially if they are having trouble securing a traditional mortgage. For the seller, owner financing offers an additional value-add that may make their home more attractive, especially in a competitive buyers market.
What it is: Refinancing an existing mortgage and taking out equity to pay for major expenses like a second home or children’s educations.
Risks: A loss in the value of the home, due to deferred maintenance, failure to stay current with the local market, or economic reversals, could result in owing more on the home than it’s worth.
Benefits: Rather than having home equity sitting and doing little or nothing to improve quality of life, it can be put to work in a positive way.
What it is: Private financing through an individual or group rather than through a financial institution. Private financing is a popular option for those who cannot qualify for a traditional mortgage or for those who are only financing short-term, with later conversion to a long-term conventional or FHA mortgage.
Risks: Private financing often carries far higher interest rates than traditional mortgages because of the added risk to the financier.
Benefits: Private financing may involve faster and more streamlined underwriting and approval and may be a good option for investors who need to act fast to secure a property or for those trying to compete in a robust sellers market.
Not everyone is financially prepared for a home purchase. Unexpected changes to your personal or professional circumstances can make it difficult to secure the funds needed for a traditional purchase process. Non-traditional mortgages can help you overcome temporary setbacks or transitions.
Talk to your lender and real estate agent about your individual circumstances. They have access to a vast financial and professional network that can help you figure out how to make your real estate dreams a reality, even when time and circumstances don’t seem to be on your side.
