A “purchase money mortgage” is a home loan used to purchase a piece of property, whether it be a principal residence, a second home, or an investment property.
If you’re looking to buy a home, you’ll generally need to apply for a purchase money mortgage to obtain financing, unless of course, you plan to pay with cash.
Most of us aren’t lucky enough to have the necessary amount of funds on hand to buy a home outright, so we must turn to a bank or mortgage lender for financing.
Purchase Money Mortgage Loans Are Easier to Qualify For
- Purchase mortgages have the most flexible underwriting guidelines
- Including the highest LTV limits available
- And the lowest credit score requirements
- Home purchase interest rates may also be cheaper than refinance rates
The good thing about home purchase loans is that they generally come with the most flexible mortgage underwriting guidelines relative to refinance loans.
In other words, you’ll be able to borrow the most amount of money at the highest loan-to-value ratio (LTV ratio) if the purpose of the loan is a home purchase.
For example, the FHA allows home purchase financing with as little as 3.5% down, and specialty programs such as Fannie Mae’s HomeReady program only require 3% down, with gifts or grants permitted to cover the small down payment.
At the same time, the credit score requirement for a purchase money mortgage will likely be the lowest out there.
Purchase Mortgages Come with Lower Interest Rates
- Purchase mortgages often come with rebates or other pricing incentives
- So the interest rate is often lower on a purchase home loan
- Relative to a comparable refinance loan
- Which may include pricing adjustments to account for more risk
Another benefit of a purchase money mortgage loan is that the associated mortgage interest rate will be lower than that of a refinance.
When you refinance your existing mortgage, mortgage lenders typically hit you with a pricing adjustment, which will increase your mortgage rate and/or closing costs to some degree.
With a purchase money mortgage, there won’t be a pricing hit, and you may even be entitled to a pricing rebate. Sometimes lenders offer purchase specials, such as a .25% credit to help cover some of your closing costs.
You can also get a second mortgage at the time you take out the first mortgage – this is known as a piggyback second, or a purchase money second mortgage. Typically, these come in the form a home equity loan/line, often from a different bank than where you get your first mortgage. However, both loans must close concurrently.
This is one way to put less down on a home purchase, while also avoiding mortgage insurance if you keep the first mortgage at or below 80% LTV. A first mortgage kept at or below 80% LTV should also result in a lower interest rate, assuming a single high-LTV loan is the alternative.
Tip: If you do use a purchase-money subordinate mortgage to obtain financing, it can later be refinanced with your first mortgage and be considered a rate and term refinance (as opposed to a cash out refi), which may result in more favorable and/or higher LTV limits.
Real Estate Agents Strongly Influence Where You Get Your Mortgage
- Many home buyers use their real estate agent’s recommended lender
- Without speaking to other lenders or shopping interest rates
- Don’t feel obligated to use their preferred bank or lender
- And certainly don’t limit your search to a single lender or rate quote
If you’re in the market for a home purchase mortgage, be sure to do plenty of shopping. I’m going to assume you didn’t buy the first house you came across.
The same should be true for the first mortgage rate quote you receive. Sure, it might be the best out there, but it’d be foolish not to take a moment to see what else is out there.
While your real estate agent may have their preferred lender, and the home seller may have theirs, it’s important to get some independent quotes as well to see how they stack up. Try your local bank, rival banks, credit unions, and mortgage brokers to obtain mortgage rates and to compare available loan programs.
There are seemingly endless scenarios, so be sure to exhaust all your resources, as buying a home is likely going to be one of the most significant financial decisions you’ll make in life.
For that reason, make sure you choose a reputable mortgage lender, not just the bank that supposedly offers the lowest rate.
You can get away with a few mistakes on a refinance, but a home purchase has a strict timeline that must be met. Errors can be costly and extremely stressful, and you certainly won’t want to lose the home because you made a bad lender decision.
Even if you don’t wind up loving your loan, you can always refinance after the fact. But if you lose the home, you might not find another like it.
Note: A purchase money mortgage may also refer to seller financing, in which the home seller provides some of the financing to enable the buyer to purchase the property who may not otherwise qualify.