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Traditional Versus Non-Traditional Home Financing

| Home Buyer Guidance

When purchasing a home, the majority of buyers choose traditional financing, as it’s the fastest and easiest way to home ownership. Some families find it difficult to qualify for a traditional loan, however, and choose to explore other options.

For buyers who have credit issues or are unable to verify adequate income, non-traditional home financing has emerged to fill the gap.

Traditional Home Buying

Traditional home lending is provided by a financial institution. Each lender offers programs that assist buyers with varying qualifications in obtaining financing. Buyers work with lenders to make prudent decisions about the best-suited programs.

Non-Traditional Home Financing

When buyers cannot meet requirements for traditional mortgages, they can either make the appropriate adjustments or look for alternative lending methods.   Some examples of non-traditional arrangements are listed below:

Rent to Own

Rent to own provides an agreement between the buyer and seller for the future purchase of the home. The price and time frame are established at the time of the rental agreement. The buyer must qualify for a traditional mortgage within the timeframe, typically one to five years. A portion of the agreed-upon rent goes into an escrow account and will count towards the buyer’s down payment.

  • Advantages: The advantage of rent to own is that the buyers can move into the home while making corrections to their credit or income, giving them time to qualify for a loan.
  • Disadvantages: A premium is paid on the rent, meaning rent is higher than it would ordinarily be. This approach also requires a non-refundable option fee, which can be several thousand dollars. If for any reason the buyer cannot purchase the home, the seller keeps the option fee.

Owner Financing

Owner Financing is a limited market. Mortgages include a clause that prevents the sale of a home without a loan payoff. As a result, the owner must own the home outright in order to offer owner financing.

  • Advantages: An owner may provide greater flexibility. The seller will not conduct extensive underwriting and may be more flexible with terms.
  • Disadvantages: To protect themselves, owners require a large down payment that could range from 20% to 50% of the sale price. The other caveat is that the seller typically wants a short-term loan, which takes the form of a balloon payment. This means the buyer makes payments to the seller for a specified period of time, after which the loan must be paid off or financed through traditional means.

Habitat for Humanity

Habitat for Humanity is a program that helps low-income buyers obtain the goal of home ownership through a community-supported building project. The prospective buyer must meet strict qualifications that are approved through a local committee. After construction is complete, Habitat for Humanity finances the home. The buyer makes payments and must continue to meet the organization’s guidelines until the home is paid off. All proceeds from the mortgage payments go toward building more homes.

  • Advantages: The low down payment requirements provide a greater opportunity for low-income buyers to own homes.
  • Disadvantages: Personal construction work is required. A specific number of construction hours must be invested into the building of the home. The qualifying process can be lengthy.

After considering the details of non-traditional financing, many home buyers decide that traditional financing may be the best option overall. A buyer can use many strategies to build a stronger financial portfolio before purchasing a home, such as saving for the down payment, carefully documenting income, paying bills on time, and correcting errors on credit reports.

By meeting with a lender before finding a home, buyers will better understand financing options and requirements for loan qualification. The better prepared the buyers are, the smoother and faster the purchasing process will be.

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