What Is Alternative Home Financing?

How Alternative Home Financing Works

In most cases, homebuyers use a mortgage to pay for a home. However, not every homebuyer is eligible for a mortgage; poor credit history, low income, and other factors can make mortgages hard to get. As a result, some homebuyers turn to alternative financing to fund their purchase. These financing methods typically include:

• Seller-financed mortgages
• Personal property loans
• Lease-to-purchase agreements
• Land contracts

Seller-Financed Mortgages

In this kind of agreement, a homebuyer borrows money from a homeowner. This eliminates the need for an outside lender. At the beginning of the deal, the buyer gains complete ownership rights. State and federal laws give limited protections to a borrower in a seller-financed mortgage deal.

Personal Property Loans

In many cases, buyers of manufactured homes rely on personal property loans. These loans frequently come from home manufacturers, although some traditional mortgage lenders issue them. These loans often come with higher interest rates and shorter payoff periods. This means that monthly payments might be difficult to handle, and interest charges may pile up.

Lease-to-Purchase Agreements

Under a lease-to-purchase arrangement, also called a “rent-to-own” deal, you start off as a tenant. Usually, you make a down payment or pay an upfront fee for the chance to buy the home later. You tend to pay a little more than the market value for rent. The extra you pay typically goes toward your down payment when you buy the home. If you decide to purchase the house, you take out a loan from the landlord or an outside lender. You might lose some or all of the rent you paid if you don’t buy the home.

Land Contracts

Land contracts are similar to seller-financed mortgages. The buyer makes payments to the seller, usually over a set period of time. However, the buyer doesn’t have outright ownership rights at the start of the deal. Instead, they typically get full ownership after the final payment is made.

History of Alternative Home Financing

Alternative home financing has been around for decades and is strongly tied to “redlining.” Redlining refers to the practice of denying a borrower based on the race or ethnicity of the applicant or the demographic makeup of the community in which the applicant wants to buy a home.

Redlining dates to the 1920s and ’30s when lenders used maps to rate neighborhoods in which homes were available. Neighborhoods marked in red were viewed as the least desirable for lenders. Often, redlined neighborhoods primarily were home to Black residents.

With the mortgage system rigged against them, homebuyers had to turn to alternative types of financing to buy a home. In some cases, people turned to contract buying as a way to get into a home. However, contract buying often included terrible terms meant to enrich the seller and work against the buyer. Over time, other alternative financing options emerged that were better than contract mortgages.

Alternative financing methods have continued to flourish as people of color, among others, have encountered obstacles in securing traditional financing. Today, Black and Latino Americans are more likely than white Americans to seek alternative home financing due to financing roadblocks.

Use of Alternative Home Financing by Latinos

Survey data released in 2022 by the Pew Charitable Trusts showed that Latino homebuyers are more likely than buyers from other racial and ethnic groups to rely on alternative home financing.

Josip Rupena, CEO of digital banking startup Milo, told The Balance via email that Latino buyers might find it easier to navigate the process of obtaining alternative home financing versus obtaining a traditional mortgage. For instance, alternative home financing applications might be more readily available in Spanish, and foreign-born applicants might not need to have a Social Security number or credit score.

 However, Rupena said those same buyers might be hit with higher interest rates and shorter payoff periods than what they’d get from traditional mortgages.

Criticism and Risks of Alternative Home Financing

Alternative home financing deals generally charge higher interest rates than traditional mortgages. In addition, these deals sometimes come with upfront fees and bigger down payments.

Additional drawbacks include:

• In many states, there’s no public record of alternative financing deals. As a result, policymakers might give little thought to regulating alternative financing.
• If a borrower defaults on an alternative financing arrangement, evictions and foreclosures might come more quickly for homes bought using alternative financing than those bought with traditional mortgages. In some cases, owners can foreclose on a home for even trivial contract violations.
• Few states have laws that govern evictions, foreclosures, and forfeitures connected to land contracts or personal property loans.
• Borrowers who depend on personal property loans to buy manufactured homes pay nearly twice the median interest rate than mortgage borrowers do.

Options Besides Alternative Home Financing

Options that are safer than alternative home financing are out there. Here are five to consider:

• Federal Housing Administration (FHA) loans: They offer low down payments, low closing costs, and looser credit requirements for first-time homebuyers.
• Homeownership vouchers: These vouchers provide subsidies for buying a home for residents of public housing, and people who earn low incomes and are first-time homebuyers.
• Department of Veterans Affairs (VA) loans: These loans are for active-duty members of the military and military veterans. Benefits of VA loans include no down payment, low interest rates, and limited closing costs.
• Department of Agriculture (USDA) loans: USDA loans are for single-family homes located in rural areas, as designated by USDA maps. One of the advantages of a USDA loan is they don’t require a down payment.
• State programs: States tend to have programs that help buyers who are struggling to finance a home purchase. Some states offer down-payment assistance programs that can help reduce your down payment.

Michael Gifford, CEO of Splitero, encourages people to look into all their financing options for buying and owning a home. Gifford’s company provides a lump sum of cash to homeowners in exchange for a share of a home’s appreciation or depreciation.

"Take your time, plan for a [potential] change in your job status or an economic downturn, and then assess the viability of taking on additional debt and monthly payments,” Gifford told The Balance via email.

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