Buying a House Without a Mortgage

By Daniel H. Stoner, Esq.

Most residential home buyers rely on mortgages when purchasing real estate. There are many obvious advantages to using a mortgage to finance your real estate transactions. The most obvious advantage is that very few people have enough cash lying around to be able to pay the entire cost of a house out of pocket. Even for wealthier people who do have enough money in the bank to be able to purchase a home out of pocket, mortgages may still be a financially advantageous choice as the interest rates for a mortgage are often lower than the annual returns one can get from common investment vehicles, thus taking out a mortgage and investing their money elsewhere may actually save them more money in the long run. Because of these things, mortgages remain extremely popular among home buyers of all income levels.

However, sometimes a mortgage may not be possible. Individuals with low credit scores may not be able to obtain approval from a bank to get a mortgage. Sometimes younger people who have just entered the workforce may not have enough of an established credit history and income history to obtain approval. There are also times when one cannot be approved for a mortgage at an acceptable interest rate or may not be approved for the full purchase price of the house. In these scenarios people may look at alternatives to a bank mortgage for financing their real estate purchases. There are several common ways in which people are able to purchase real estate without having to use a mortgage from a bank.

The most obvious mortgage alternative is to simply pay in lump sum cash. While cash purchases are common among real estate investors and people who flip houses for a living, they are rarely used by people who are purchasing a home. However, if one is purchasing a property via sheriff’s sale from a foreclosure or a home from an estate sale of a deceased person they often are required to pay in cash. Buying a home from a sheriff’s sale can allow one to purchase a house at a steep discount, however it can also be very risky. Often times foreclosed homes may have significant tax liens on them, or other issues clouding their title. It is very common for foreclosed homes to sit vacant for years before they are finally auctioned off, which means that significant deterioration or vandalism may occur. Thus, a property that may seem like a great bargain could actually come with significant costs and burdens that are not reflected in the purchase price at auction. While savvy real estate investors often buy homes from sheriff’s sales and turn significant profits, it is extremely risky for an average home buyer to buy a home at a sheriff’s sale and we generally recommend buyers to avoid buying a home at a sheriff’s sale unless they have done some serious homework and know what they are doing.

Another common way to buy a home without a mortgage from a bank is a simple rent-to-own agreement, also known as an installment land contract. An installment purchase agreement usually consists of a contract between the buyer and seller whereby the buyer agrees to pay the owner a monthly fee for a period of time (usually 2 to 5 years), at the end of that period and when the buyer has paid a certain amount of money, the buyer either owns the house outright or has the option to purchase the home at an agreed upon payment. Sometimes, instead of monthly payments the payments are made in several installments that occur on a quarterly basis or even a 6 month or yearly basis. Normally the buyer lives in the home during this time period and acts essentially as a tenant while the seller remains the record owner until the contract is completed. This kind of transaction can be advantageous for buyers since it does not involve a significant out of pocket payment up front and allows them to slowly pay for the home over time just like one does when they use a mortgage. However, this method also has several drawbacks. Many sellers do not want to use this method since they would rather be paid up front in a lump sum, which they can do with a mortgage. If the seller herself has a mortgage on the home, the terms of the mortgage may not allow them to use this method. Also, in my experience, I’ve found that often times such contracts are drafted by the parties themselves and not by a professional, and as such there are often vagaries or weaknesses in the contract that can lead to problems down the road.

Sometimes the seller may change their mind several years into the contract and try to remove the buyer from the home. In those instances, with a poorly written contract, courts may treat the buyer as a simply being a tenant who can be evicted, especially if the monthly price is similar to what the market rate for rent would be. In that case the buyer may never get to actually won the house, even if they’ve spent considerable time at the property and have made numerous investments in the property. Also, since the title to the house remains in the seller’s name during this period, things such as property tax payments and insurance payments may remain the seller’s responsibility. If the seller fails to pay the taxes or other fees on the property, the property may be put in jeopardy. Because of these things, this kind of arrangement is not always the most secure for the buyer and many problems can arise. Often times the contracts used are very rudimentary and simple and do not address possibilities such as the ones described above. If you do wish to use this method to purchase or sell a home, it is absolutely crucial that you contact an attorney to have the contract reviewed. Most attorneys will be able to review or draft a contract at a reasonable price which will make the arrangement much more transparent and secure for the buyer as well as the seller.

Buyers may also purchase a home without a mortgage from a bank by using a private mortgage. A private mortgage is similar to a bank mortgage, except the mortgage is held by the seller (or another private third party) rather than by a bank. We often recommend this method over a rent to own agreement as it tends to be more secure and has lower risk. With a private mortgage, the buyer agrees to pay the seller a monthly fee over a set period of time until the entire purchase price is paid just like in a rent to own agreement. However, unlike a rent to own agreement, the title is transferred to the buyer at the beginning rather than the end. In return the seller will place a mortgage on the property in his or her name. If the buyer fails to make payments to the seller, the seller can use the mortgage to initiate foreclosure proceedings and take the home back. There are several advantages to using a private mortgage. Because the title is transferred at the onset of the arrangement, the buyer will be the record owner and thus responsible for things such as property taxes and insurance. This lowers the risks for buyers which can occur when the sellers retain title and may not follow through with all of their responsibilities. Also, if the seller later changes their mind and wants their home back, they will be unable to simply evict the buyer as what often happens in installment contracts. Because the buyer is the record owner, the only way in which the seller can take the home from them is if the buyer fails to follow through with the terms of the mortgage.

A private mortgage is often more transparent and secure for the parties than an installment contract, as such we usually recommend it over other methods. While a private mortgage may be slightly more expensive to have done than a simple installment contract, it adds extra security to the arrangement which can save significant costs down the road. Just like with an installment contract, you would need to find a seller who is willing to enter into this kind of arrangement, and it is important to contact an attorney to make sure it is done right.

There are several ways to buy a home without getting a mortgage from a bank as we have just described. They all have their advantages and drawbacks, however we have successfully helped many people purchase homes without having to have a bank mortgage involved. The key to having these arrangements work is to make sure there is a clear agreement between the buyer and seller which will prevent problems from arising down the road. If there are ambiguities in the contract there can be significant problems which can occur later on which could lead to expensive litigation or the buyer losing the home. If you do wish to purchase or sell a home without a bank mortgage, it is important to contact an attorney to ensure that the sale is one the right way. Often times the price of having the contract done right is much lower than the commissions you will pay for a real estate agent, and it will certainly be many times lower than the costs of fixing problems from an agreement which was not made the right way.