Financing a home purchase: 6 creative ways
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Given the current interest-rate environment, high prices and recession fears, many potential homebuyers find themselves priced out of typical mortgage financing. It’s no wonder, considering that mortgage rates skyrocketed in the past year, rising from around 3.25 percent for a 30-year fixed in December 2021 to around 6.62 percent in December 2022.
Fortunately, whether you’re unable to qualify for a conventional mortgage or just looking at all your options, there are other, less traditional financing methods out there. A 2022 survey from Pew Charitable Trusts found that about 1 in 5 U.S. home borrowers, or approximately 36 million Americans, have used alternative methods of financing. Here are six creative alternatives to traditional mortgages for eager homebuyers to think about — some have a certain amount of risk involved, so consider carefully.
1. Down payment assistance programs
Taking advantage of state or local down payment assistance programs does not exclude you from needing a typical mortgage — you will still need one — but they are a very low-risk method of getting some much-needed financial help. Each program will have a different set of qualifications that must be met, but they are typically offered mostly to first-time homebuyers and people who plan on using the home as their primary residence.
These assistance programs can include government grants, which don’t have to be paid back. They may also take the form of low-interest or zero-interest loans, deferred-payment loans or forgivable loans, which don’t need to be paid back as long as you remain in the home for a specified period of time.
2. Government-backed programs
Mortgage programs that are backed by the U.S. government are also low-risk, and many come with low or even no down payment requirements:
- VA loans: Available to active-duty military members and veterans, as well as some military spouses, VA loans are guaranteed by the U.S. Department of Veterans Affairs. Most require no down payment at all and have low or no minimum credit scores.
- FHA loans: An FHA loan is backed by the Federal Housing Administration. These loans have lower down payment and credit score requirements than conventional loans and are especially popular among first-time buyers. However, they do require the buyer to purchase FHA mortgage insurance.
- USDA loans: Buyers in rural areas may qualify for a USDA loan. These were created by the U.S. Department of Agriculture to encourage homeownership in non-urban regions — the home must be located in a USDA-approved area. These loans require no down payment and tend to have looser credit requirements than conventional mortgages.
3. Balloon and piggyback loans
These unusual types of mortgages both have major disadvantages, but they can be useful in certain situations. A balloon mortgage is so named because it involves a relatively short length of time with low or even no monthly payments, followed by one huge lump-sum payment at the end of the term, known as a balloon payment. These are not very common, because they’re risky for both the borrower and the lender. You might be lulled into a false sense of security in the first few years, but you will still owe the full amount in the end, so you must be sure you’ll be able to afford the full amount by then. House-flippers often like these loans because when they sell the house, they are able to put the proceeds toward the balloon payment.
A piggyback loan carries less risk, but it has its own downsides. As the name implies, it is really two mortgage loans, one piggybacking on the other. This means two different interest rates, two monthly payments and two sets of closing costs. Piggyback loans are often referred to as 80/10/10 loans because you get one loan for 80 percent of the purchase price and one for 10 percent, with the other 10 percent being paid upfront as the down payment. The benefit is that it can eliminate the need for private mortgage insurance or a jumbo loan.
Sometimes called a lease-to-buy program, renting to own a home is not unlike leasing a car: You rent the place for now, with an option to buy it later. Typically, a pre-arranged contract spells out the terms of the eventual purchase, including the price, and the tenant may choose to exercise the purchase option or not. Often, a portion of the rent payments is applied toward the purchase price if the tenant decides to buy. These arrangements can be great for those who can’t afford to buy a home yet but are diligently working their way toward it. However, if property values change drastically or you are still unable to afford a mortgage at the end of the rental term, you could lose money or run into issues.
5. Seller financing
In rare cases, a buyer may be able to secure financing directly from the seller of the home, particularly if the seller owns the home free and clear. Seller or owner financing is similar to a traditional mortgage, but rather than a bank lending you money, the home’s owner is lending it to you, and taking on the debt. This may be beneficial to buyers who would not qualify for financing otherwise — in some cases, buyers may take out a mortgage for part of the purchase price and finance the rest via the seller. However, these situations usually involve a much higher interest rate than a standard mortgage, and often require a balloon payment as well.
6. Borrowing from a retirement account
If you’re really between a rock and a hard place, you could potentially borrow from a retirement account to pay for your home — but it’s a risky step. Taking out a 401(k) loan is generally not recommended. There are likely to be limitations on how much you can take out, and doing so could mean paying penalties and taxes. And even though you’re borrowing your own money, you’ll still have to pay yourself back, with interest. In addition, remember that your 401(k) is tied to your job — if you leave your current job for whatever reason, you may have to pay the money back more quickly than you’d anticipated, and you can’t borrow from a 401k from a company you no longer work for unless you’ve rolled it over into another account.
If you don’t qualify for a conventional mortgage right now, don’t give up on homeownership just yet: There are several nontraditional, alternative ways to finance, or at least help finance, a home purchase. However, while some options are solidly government-backed, others are very risky. Do your research and be sure you’re choosing a financing method that will work for your specific needs.