If you're interested in making your first home purchase -- or perhaps selling your current home and purchasing a different one -- you're likely investigating all your financing options. Although most mortgages are financed through a traditional bank or credit union, there are a rising number of alternative arrangements for those who don't have the credit history to obtain favorable interest rates or simply don't want to be locked into a decades-long loan. Read on to learn more about some common alternatives to traditional bank financing, as well as a quick overview of the laws and regulations governing these types of transactions.
Land contracts
These agreements are common in many rural areas across the country, as well as for rental homes that current renters who cannot obtain traditional bank financing wish to purchase. A land contract operates on the opposite principle as a bank mortgage. Instead of purchasing a deed and then mortgaging an interest in that deed to the bank, you're making monthly payments of a predetermined amount to obtain possession of the deed -- just like a rent-to-own arrangement. After you make the final land contract payment, the deed is transferred into your name.
Be aware that a land contract does not provide as many buyer protections as a mortgage loan. If you miss a mortgage payment, the lender will need to go through a potentially lengthy foreclosure process and sheriff's sale before obtaining possession of your home. If your home has equity when it's sold at sheriff's sale, the money in excess of the amount needed to pay off the mortgage and any penalties is yours to keep. On the other hand, if you miss a land contract payment, the owner may be able to evict you quickly and without foreclosing the loan. Any equity you had in the home at the time of eviction now belongs to the owner.
If you choose to explore a land contract, be sure to consult with an experienced real estate attorney before entering into the transaction. This attorney will be able to draft and review any potential agreements so that your interests are well-protected.
Loans from family members
If you have a family member who is willing to lend you money at a competitive interest rate, this can be a very viable option to explore. Loans from family members often come with fewer strings attached and potential penalties than a bank loan. For example, if you lose your job and are unable to make payments for a few months, a family member tends to be a bit more forgiving than a large bank headquartered in another state. However, there are now federal regulations governing these types of private loans (as well as land contracts) -- and if your lending family member doesn't abide by these regulations, he or she could potentially be facing hefty fines or even the invalidation of the mortgage.
In general, when making the loan to a family member, your relative will need to undertake the same type of approval process (and abide by the same parameters) as other lenders. This means your relative may need to ask for your last several years' tax returns, run a credit report, and ask you about your monthly budget. It also means that if the loan was being extended to help you "stretch" into a home that's beyond your current means, or to help you purchase a home when your debt-to-income ratio is too high to qualify for traditional financing, the loan could later be ruled invalid (requiring you to immediately repay it).
As with a land contract, you should consult with an experienced attorney before entering into this type of transaction to ensure that both parties are adequately protected.
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