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A mortgage loan is the most traditional way to buy a home. You’re going through a bank for a loan and the monthly payments will be the same for 15 to 30 years, depending on the terms of your loan.
But if you can’t qualify for a mortgage, there are non-traditional ways to finance a home. Here are seven alternative ways to finance a home, though some come with caveats on when they might not be a good idea:
1 – Borrow From a Retirement Account
Borrowing from a 401(k) sounds like a good, short-term idea if you have enough money in your 401(k) or IRA because you’re basically borrowing money from yourself.
If you’re under 59-1/2 years old, you’ll have to pay a 10% penalty on the withdrawal and will pay taxes on it. If you lose your job, the money has to be repaid within 60 days. But if you are okay with all of those hassles, it could be worthwhile.
“There are few, if any, circumstances I’d recommend people borrow from their 401(k) to buy a house,” warns Tyler Gray, a financial advisor at SageOak Financial in Tulsa, OK. You’re harming your retirement prospects and have to pay taxes on the withdrawals. Additionally, 401(k) withdrawals count as income, so it may inadvertently put you in a higher tax bracket.
Borrowing from a Roth IRA may be easier than a 401(k) and can be a good option for first-time homeowners, says Marge Peck of Discover Arizona Real Estate in Phoenix, Ariz.
“The Roth is an after-tax IRA, so you can withdraw and will only be taxed on earnings,” Peck says. “Be sure this is a good investment. Also, talk with your financial advisor so you don’t trigger any tax penalties.”
2 – Borrow From Your Parents
Get the loan in writing by hiring a lawyer to write up a promissory note and a written contract. Consult an accountant so that the loan doesn’t appear as a gift, which would subject it to the gift tax.
Again, this is a loan that Gray doesn’t recommend, partly because it “completely changes the dynamic of the relationship and not usually in a good way,” he says. “It’s better the family member will just give you the money with no expectation to be paid back, and then when you do make payments, it will be a happy surprise.”
There are even some companies that specialize in family mortgages and will facilitate home loans between relatives.
» MORE: See today’s refinance rates
3 – Borrow From Your Insurance Policy
Many whole or variable life insurance policies allow policyholders to take a loan against the principal. The good news is you won’t have to repay the loan, though your heirs will end up with less money from the life insurance policy.
Borrowing against a life insurance policy with cash value is a form of self-borrowing. The cash value in the policy can be used to secure a loan, and future premiums can be directed toward repaying the loan. This borrowing process can be facilitated directly through the insurer, with rates varying between fixed and variable options.
Lenders may offer loans based on a percentage of the policy’s cash value. However, opting to borrow against the cash value independently might provide a more favorable rate and access to a larger sum of money.
It’s important to carefully review the policy terms and be aware of any potential reduction in the death benefit due to the cash value loan and how this might affect your family.
4 – Get a Co-signer
If you don’t want to ask your parents for a loan, try getting them on as a co-signer for the loan.
Even if you could afford a home loan yourself, there are advantages to getting a co-signer. If you’re in a competitive market, it will make qualifying for a loan easier—and your loan will have much more favorable terms.
With a strong co-signer, you’ll have better interest rates, which can save thousands of dollars over the course of a loan term. You’ll also appear to be a more competitive borrower to sellers, as your debt-to-income ratio will skyrocket. This can give you an edge against other buyers in a competitive market.
5 – Seller Financing
Seller financing works similarly to a traditional mortgage with a bank. In this arrangement, the home seller is acting as the bank and would hold the mortgage while you make payments to them.
Essentially, you’ll be living in the house and will be responsible for the upkeep and maintenance of the home. However, instead of making payments to a bank with the end goal of owning the home completely, you’ll be making payments to the seller.
The terms of the seller financing agreement can vary and are often negotiable, including details such as interest rates, repayment schedules, and other financial aspects.
This process allows individuals who might face challenges securing a mortgage through traditional means, such as due to credit issues or unconventional financial circumstances, to still participate in a real estate transaction.
6 – Rent-to-Own
This option can work for both sides if the buyer can come up with a large enough down payment to make it worthwhile for the seller. A certain amount of the monthly rent would go toward credit for buying the home at the end of the contract, often within a year.
Or, the purchase price could be increased by $50,000 to make it worthwhile to the seller, who is essentially giving the buyer an interest-free loan for a year while they live in the house. All of the rental money for the year could then be put toward the down payment on the house.
However, the rent-to-own option will vary depending on your lease agreement. Some agreements will only allow you to make payments toward ownership after renting for a specific length of time.
7 – Save More for a Down Payment
The common 20% down payment is preferable, but no longer needed by many lenders. But if you still can’t come up with enough of a down payment, then save your money for a few years until you can qualify for a traditional mortgage.
You can also seek alternative loans for a lower down payment. If you qualify for the VA loan, FHA loan, or USDA loan, your down payment requirement will be reduced drastically. VA and USDA loans don’t require a down payment, and FHA loans have a small requirement of 3.5%.
Is an alternative mortgage right for you?
Alternative mortgage options may be right for specific borrowers, but you should proceed with caution.
Mortgage alternatives should not be viewed as risk-free solutions. Before exploring non-traditional options, try to improve your chances at qualifying for a traditional mortgage—you’ll be able to get a better rate and it’ll help in the long run.
You have a better shot at qualifying if you minimize your debt-to-income ratio, improve your credit, and save for a larger down payment.