Financing a Purchase when a Conventional Mortgage is not an Option
Alternative Financing Methods in a Slow Real Estate Market
Most real estate transactions involve buyers financing the transaction through a combination of cash and conventional financing with a mortgage lender. With conventional financing, the seller receives payment for the real estate purchased, and the buyer receives title and possession to the property at closing.
Periodically, market conditions cause buyers to seek alternatives to conventional financing. In the 1980's, alternative financing methods were common because of high interest rates. Alternative financing is becoming popular again, this time because of increased restrictions on lending and a high volume of homes on the market. Buyers who are unable to obtain conventional financing are finding sellers more willing to provide seller financing for a transaction in order to sell their property.
These alternatives require the seller to be involved in the transaction long after the time that a typical closing would have taken place. Alternatives to conventional financing include: lease with option to purchase, contract for deed, or seller financing through a note and mortgage. What follows is a brief description of these methods, and the impact on the buyer and seller.
Lease with Option to Purchase: In a lease with option to purchase, instead of immediately purchasing a property, a prospective buyer will lease the property for a period of time. One of the terms of the lease will give the prospective buyer the option to purchase the property for a predetermined purchase price. The option to purchase will typically be held open for a period of one to three years. The seller continues to own the property until the buyer exercises the option to purchase.
The advantage to the buyer in a lease with option to purchase is that they have a right to purchase the property, and additional time to secure financing for the purchase. The seller benefits by receiving rental income, and a potential buyer for the property.
Contract for Deed: A contract for deed is a transaction where the buyer, instead of leasing the property, makes monthly payments towards the purchase of the property. This option is more popular than a lease with option to purchase, in large part because it feels more like a sale to both the buyer and seller. There are a couple of reasons for this. First, Minnesota law requires the contract for deed to be recorded, giving the buyer an immediate, and public interest in the property. The seller still holds record title to the property, but the seller's role is more similar to that of a lender. Second, under most contract for deed transactions the buyer truly steps into an ownership role and is responsible for maintenance, taxes and insurance on the property.
Like the lease with option, a contract for deed can be beneficial to buyers and sellers when a traditional sale is not an option. In this option, the buyer obtains financing in a situation where conventional financing may not have been available. Unlike the lease option, the seller has the advantage of passing many of the ownership responsibilities to the buyer, and having a buyer who is contractually obligated to purchase the property.
Seller Financing: This option is less common than a contract for deed, but is another option available where a buyer cannot obtain conventional financing. Using this option, the closing will occur quickly, like a conventional sale. The buyer immediately receives title to the property, but the seller continues to be involved as a lender. Like a bank in a conventional financing situation, the seller will loan the buyer all or part of the purchase price, and receive in return a note and mortgage. The mortgage secures the buyer's interest in the property, giving the seller the right to foreclose if payment is not received. Although not as popular as a contract for deed, it may be worth considering under certain circumstances.
While conventional financing is normally the best option, these alternative methods are available to buyer who otherwise could not purchase. Before using one of these methods both buyers and sellers should seek advice about which option makes the most sense for their transaction. If you have questions regarding the content of this article, please contact Cameron Kelly at 651-705-6277. www.cameronkellylaw.com