Whether you're a first-time homebuyer, a repeat buyer or an
investor, you might have reasons why you don't want to - or can't - obtain a
traditional mortgage. Maybe lenders don't see you as being in ideal financial
health because of a foreclosure or bankruptcy in your credit history. Or maybe
you have plenty of assets in the bank but can't show sufficient monthly cash
flow to convince a lender that you will be able to make the monthly payments.
Or perhaps you're a small business owner with irregular income.
Whatever the reason, there are other ways to finance large
purchases such as real estate. Here are a few of the most common options.
1. Borrowing
From Your Whole Life Policy
A whole life insurance policy is one that accumulates cash
value over time as you make your regular premium payments and earn dividends
and interest. It's possible to borrow against this cash value, and when you
borrow from your own whole life insurance policy, there is no loan
qualification process. While such a strategy increases your borrowing potential,
it reduces the face value of the policy if not paid back.
You may not have to answer a lot of questions to borrow this
money, but there are some important questions you should ask your insurance
company:
- What is the interest rate on this loan?
- Will it reduce my annual dividend?
- Will my withdrawal be taxable?
- How will this loan affect my policy's death benefit?
- Could my loan eventually cause my policy to lapse?
Additionally, you should ask yourself these questions:
- Will I really repay the loan?
- What is the opportunity cost of borrowing this money?
- What are the consequences of a reduced death benefit for
my beneficiaries?
If you have a whole life policy that you can borrow from,
don't lose sight of why you originally took out the policy. Make sure that the
expected benefits of owning property outweigh the drawbacks of borrowing from
your plan.
2. Seller
Financing
With seller financing, you bypass the bank and make mortgage
payments directly to the person you bought the house from. The official
agreement that defines the principal amount, interest rate, repayment schedule,
consequences of default and other terms is usually drawn up in the form of a
promissory note.
A seller might offer financing if he or she is having
trouble selling the property or the housing market is weak. However, most
sellers don't offer this option for one of the following reasons:
a) They don't own the
house free and clear.
Mortgage agreements commonly require the mortgage to be paid
in full when the property is sold through seller financing means. Thus,
homeowners carrying mortgages need to receive the full proceeds from the sale
immediately.
b) They don't want to
become lenders.
While seller financing can provide a better rate of return
than the seller could get elsewhere, the additional risk and hassle may not be
worth it to them. That being said, the seller doesn't have to become a lender.
He or she can arrange to immediately resell the promissory note to an investor
in what is known as a simultaneous closing.
When the option is available, seller financing has many
potential benefits for buyers. The closing process can be faster, since strict
bank requirements can be bypassed, and it's also less expensive, since there is
no need to pay a mortgage origination fee or other lending fees that banks
commonly charge. The terms of the mortgage and the criteria you need to meet to
qualify are entirely up to you and the seller, which means there's plenty of
flexibility and room to negotiate.
However, if you couldn't get a loan from the bank, why
should an individual want to offer you financing? You'll need to be prepared to
answer this question and prove that you're a worthy borrower. You should also
expect to pay a higher interest rate to compensate the seller for the risk of
lending to you.
3. Borrowing
From a Self-Directed IRA
Self-directed IRAs are a tool for investing in a wide
variety of nontraditional assets, one of which is mortgages. A self-directed
IRA differs from the Roth or traditional IRA you may already be familiar with
in that the investment options the IRS allows for a self-directed IRA are much
broader and can to a large part be dictated by the policyholder
While you cannot purchase a home for yourself using your own
self-directed IRA because of IRS rules that disallow what is called
"self-dealing," someone else who is not your lineal relative or
business partner can use their self-directed IRA assets to lend you money to
buy a house.
Robin Daniels, a real estate agent, investor and landlord
with YourHouseBuyer.com in Central Florida, says, "If an owner-occupant
wants to use IRA money to buy a house, they could borrow it from my IRA
(assuming I am not related to them), and I would either get a partial interest
in the house (requiring no payments), or lend them the money like a regular
mortgage."
Daniels has also used
this strategy as a borrower.
"I bought a trashed house two years ago for $100,000. I
paid $50,000 and borrowed $50,000 from another investor's IRA. We agreed to
split the profits. Five months later we sold the house for $182,000," she
says.
David Coe, founder of Southern California-based retirement
consulting firm Freedom Growth, says, "While a bank may not be willing to
loan due to poor credit or other factors with the property, private investors
are stepping in to help with acquisition loans. Shorter in term, and higher in
rate and down payment, these loans allow an individual to secure a property
then proceed with repairing the property, their credit or both. Once repaired,
they then refinance into a longer, lower-rate mortgage."
What's in it for the IRA owner? Coe says, "IRA owners
love these loans due to their short-term nature, the upfront fees and the high
rate of return, usually in the 8-12% range."
4. Rent to
Own/Lease Option
A rent-to-own arrangement, also called a lease option, lease
to own or lease to buy, allows a homebuyer to rent a property for a specified
initial term with an option to buy the property at the end of that term.
Monthly rent payments are generally higher than market price, with the surplus
going toward a future down payment. If the buyer opts not to purchase the
property, the extra rent is forfeited.
Renting to own can be a good option for homeowners who
aren't quite financially ready to buy but expect to be within the next three
years. Perhaps they need time to amass savings and/or improve their credit
score enough to qualify for a loan. Renting to own can also be attractive to
individuals who are not sure if they will be moving in the next few years and
want to keep their options open.
In rare circumstances, individuals may be able to turn a
pure rental situation into a rent-to-own opportunity. That's what journalist
Mary Pittman of Vero Beach, Florida, did with her house rental agreement.
She explains, "The fact that it wasn't for sale really
didn't matter to me. At the end of the lease, I told my landlord that I was
looking to buy a place." She asked if he would consider selling her the
property, and they were able to reach an agreement that included seller
financing based on her track record of making timely rent payments for a year.
The rent she had already paid didn't go toward the purchase price like it would
have in a typical rent-to-own arrangement, but the deal made sense for her.
Avoiding Pitfalls
In addition to the issues listed above, you should watch out
for other potential problems with alternative financing.
Marcus McCue, a vice president at Texas-based Guardian
Mortgage Co., Inc., advises that "unusual methods of financing a home can
have some serious repercussions," including affecting retirement planning
and incurring additional costs in the form of higher interest rates.