No matter how high your credit score or how large your down payment, your dream home might not qualify for a traditional mortgage. There are many reasons why certain properties will not qualify for a traditional mortgage. Unpermitted additions, untreated damage, incomplete renovations and no available comps in the area are just a few possibilities. The last of those four examples could be the reason why the earthship, geodesic dome house or other unique property you placed an offer on failed to qualify for traditional mortgage financing. Without “comparable” properties in the area, it can be very difficult for appraisers to determine the home’s value. Oftentimes, this means the home is appraised below the listing price. This could then cause financing to fall through. If your dream home is an off-grid cabin in the mountains or a farmlette along the coast, you might not be able to buy the property with a traditional home loan. Instead, you might apply for a land loan, construction loan, FHA 203(k) loan or personal loan. You might also consider cash-out refinancing, seller financing or financing through a local credit union. Below, we explain what can disqualify a home from traditional financing and what to do if the house you want will not qualify for a mortgage. Follow along for a list of six ways to finance your alternative home purchase in 2022.
What Disqualifies a Home From Traditional Financing?
#1 The House Was Never Completed or Renovations Were Left Unfinished
Homes must be livable in order to qualify for a traditional mortgage. As such, homes that were never completed by the builder and those with major renovations that were never finished – e.g. a kitchen remodel or second story addition – rarely qualify. Whether an incomplete construction qualifies for financing depends on if the lender considers the home habitable. Writing for The Nest in her article “Habitability Laws for Mortgage,” Jessica McElrath explains. McElrath writes that “many mortgages, especially those insured by the federal government, have habitability requirements.” In most cases, the home must be deemed a “safe dwelling” and meet all necessary requirements “established by the Code of Federal Regulations.”
In order to qualify for a traditional mortgage, the home must already meet these standards or must be able to meet the standards without the buyer “having to spend more than 5 percent of the fair market value of the property.” Code of Federal Regulations standards for a safe dwelling typically “include heating, an electrical supply, cooking facilities, a supply of hot and cold water, a method of sewage disposal and structural stability that is sound and free of hazards.” Buyers who mortgage their homes through the FHA 203(k) loan program are exempt from most standards. With an FHA 203(k) rehab loan, buyers can borrow as much as 110% of a distressed property’s estimated future value to cover the cost of repairs and renovations.
#2 There Are No Comparable Properties Nearby
If a home is unlike any others in its neighborhood, that home might not qualify for traditional financing. Homes with lots of custom work, atypical additions and energy-saving elements that are not yet standard rarely sit beside similar properties. In his article “Things To Consider When Buying A Unique Home” for Rocket Mortgage, Andrew Dehan explains. Dehan writes that without comps, “an appraiser might have a hard time appraising the home for building code and quality.” If the appraiser cannot find comparable properties in your area, “an accurate appraisal of your unique home could be challenging.” If the appraisal is below the listing price, “this may cause issues with your mortgage lender, who won’t want to overpay for the home.”
Houses that are much larger or fancier than those in the surrounding area might also struggle to secure traditional financing. Quoting Gloria Shulman in his article “5 Homes That Can Be Hard to Mortgage” for MortgageLoan.com, Kirk Haverkamp explains. The Centek Capital Group founder notes that one issue with overbuilt homes is “‘comparables from other homes sold in the neighborhood won’t match up.’” Without comps, “‘the overbuilt home is not worth as much as the builder put into it.’” In some cases, buyers can still get a traditional home loan – even if the house appraised far lower than the list price. If their lender allows, the buyer can simply add the difference between the list price and appraised value to their down payment. However, your lender will not allow this work-around if they consider the investment too risky.
#3 There Are Illegal or Unpermitted Additions
Mortgage lenders might refuse to approve a home loan if the current owner conducted unpermitted renovations or constructed illegal additions on the property. Sometimes, these additions and/or renovations are immediately obvious to the buyer. Other times, they pop up during the home inspection required by mortgage brokers and underwriters. If these additions or renovations make the home inhabitable or unsafe, the lender might pull your application. Unpermitted renovations could also complicate the property’s title. In her article “Why You Need to Check for Unpermitted Work Before Buying” for MillionAcres, Lena Katz explains. Quoting appraiser Dina Miller, Katz writes “‘if the improvements are not recognized by the town, you won’t be able to get a clear title.’” Banks refuse to lend “if the property does not match the town’s record” because banks want “consistency between the appraisal and town record.”
Even if a certified home inspector does find unpermitted additions or illegal construction, you might still be able to salvage the real estate transaction. In his article “How renovations done without permits can affect a home sale” for Bankrate.com, Zach Wichter explains. Wichter writes “It’s true that work done without permits can complicate a home sale, but it doesn’t have to derail the whole thing.” In order to proceed with the sale, the seller will need to permit the work retroactively. Unfortunately, “getting permits pulled for finished work can be costlier than having them filed upfront.” If getting the work permitted retroactively fails, “sellers could be required to undo their updates.”
#4 There Are Liens on the House’s Title
Lastly, a home might not qualify for traditional financing if there are liens on the house’s title. When a lender files a lien against your property, this gives them the option to foreclose on your home if you violate any terms. Dima Williams identifies several common types of liens that could complicate a title in her article “Mortgage liens” for Bankrate.com. These include a property tax lien, federal tax lien, homeowner’s association lien, mechanic’s lien and judgement lien.
Property and federal tax liens are placed on a property when the owner has failed to pay taxes due to the government. Most of the time, the taxes due are property taxes. If the property has an HOA lien, this means that the owner failed to pay dues to their community’s homeowners association. With a mechanic’s lien, the homeowner failed to pay a contractor for work done on the property. With a judgement lien, the owner failed to pay off some other sort of debt. In the latter case, a lien is placed on the property until “credit card debt, outstanding medical bills or personal loans” are paid off.
Why Liens Disqualify Properties from Traditional Financing
In our post “How Much Are Closing Costs for Home Buyers?” we note that most lenders require buyers to pay for a title search. This is paid by the buyer as part of their closing costs before an underwriter approves the home loan. During a property title search, a title company or real estate attorney will go through documents related to the home’s legal history. As mentioned above, liens and elements that could complicate your right to ownership will usually come up during a title search. Writing for RocketMortgage in “Liens: Everything You Need To Know,” Molly Grace elaborates. Grace notes that “mortgage lenders won’t approve a mortgage if the property has any outstanding liens.” Those who wish to buy a house with a lien must wait for the seller to pay off the debt first.
6 Alternatives to Traditional Mortgage Financing for Unconventional Homes
The following alternatives to traditional mortgage financing allow buyers to purchase unconventional properties. However, these alternatives rarely offer terms as desirable as those of a traditional home loan backed by a recognized financial institution. For example, interest rates might be higher and repayment terms might be shorter. Some prevent buyers from building equity in their new homes until years have passed. From balloon loans to lease to own agreements, follow below to learn all about six alternative financing options for unique properties.
#1 Balloon Loan
First on our list of nontraditional financing options is the balloon mortgage or balloon loan. In the article “Nontraditional Mortgages, Explained” for Rocket Mortgage, Sydney Richardson explains. Richardson writes that a “balloon loan is a mortgage that operates on a lump-sum payment schedule.” For buyers, this means that “at some point in the life of your loan…you’ll pay the remainder of the balance at once.” When and how you pay off a balloon loan depends on terms set by your specific lender.
According to Richardson, “you may pay only interest for the life of your loan and then one big principal payment at the end.” Alternatively, you might pay “a combination of interest and principal, with a somewhat smaller lump-sum payment at the end.” This all depends on your lender. Balloon loans offer home buyers low monthly payments, low interest rates “and the ability to use your money for other things.” However, buyers must be able to pay the lump sum at the end of their loan term in order to avoid default. This term is usually between five and seven years as opposed to the typical 10, 15 or 30-year mortgage terms. Homeowners often sell their house at the end of the term and use the proceeds of this sale to make their balloon payment.
Risks of Buying a House with a Balloon Mortgage
Writing for Investopedia in her article “Balloon Loan Definition,” Julia Kagan outlines the potential risks of financing your purchase with this type of mortgage. First, buyers might end up defaulting on their loan if they “cannot convince their current lender…to finance the balloon payment.” In this case, they “cannot raise the funds to pay off the principal balance.”
Second, if the value of your house has decreased, you might be “unable to sell the property at a high enough price.” If your home sells for less than the balloon payment, you must either pay cash or default. Lastly, you might be able to refinance the loan and avoid defaulting on the balloon payment. If interest rates are higher than they were initially, however, your monthly mortgage payment will be much higher.
#2 Construction Loan
Another way to buy a house without a mortgage is to apply for a construction loan. Buyers often apply for construction loans when purchasing a distressed property. A distressed property is one that has either fallen into disrepair, was never finished or includes incomplete renovations. In “How Construction Loans Help Finance Your Dream House” for NerdWallet, Linda Bell and CFP Hal M. Bundrick explain. According to Bell and Bundrick, “construction loans are shorter term, higher interest rate mortgages that cover the cost of building or rehabilitating a house.” Unlike a traditional mortgage, construction loans are paid to the contractor rather than the borrower “as building milestones are achieved.” Once the build is complete, “home construction loans are either converted to permanent mortgages or paid in full” by the borrower.
There are three main types of construction loans: construction-to-permanent loans, construction-only loans and renovation construction loans. Amongst typical homeowners – not developers – the two most popular types are construction-to-permanent loans and renovation construction loans. Construction-to-permanent loans allow the borrower to pay off their loan like a traditional mortgage once construction is complete. With these types of loans, “interest rates are locked in at closing,” making budgeting monthly payments a bit easier. Alternatively, “the cost of major renovations are wrapped into the mortgage instead of financed after closing” with a renovation construction loan. In this case, the loan amount is based on the home’s future estimated value following necessary repairs. Technically, an FHA 203(k) loan is a renovation construction loan.
What is an FHA 203(k) Loan?
Technically, FHA 203(k) loans are a type of renovation construction loan. In an article about FHA 203(k) loans for Investopedia, Julia Kagan explains. Kagan writes that “an FHA 203(k) loan is a government-insured mortgage that allows the borrower to take out one loan for two purposes.” These two purposes are “home purchase and home renovation.” FHA 203(k) loans are usually used to finance the purchase of a fixer-upper. Another important note: this home must serve as the buyer’s primary residence once repairs are made.
According to Kagan, FHA 203(k) loans “are intended to support homeownership among lower-income households.” These loans allow buyers with lower incomes “‘to improve and update older properties as their primary residence.” There are different types of FHA 203(k) loans available to buyers: limited 203(k) and standard 203(k). The former is for homes that require minimal repairs totaling less than $35K. The latter is for properties that require extensive work totaling no less than $5K. Standard loans are more complex, involving multiple rounds of inspections. Interest payments are usually no higher than the typical rate at the time of purchase.
#3 Personal Loan
Next on our list of ways to buy a house without a mortgage is to take out a personal loan. While unconventional, some buyers will use a personal loan to cover part of their purchase – usually the down payment. In “Can You Buy a House With a Personal Loan?” for Experian, Ben Luthi explains when a personal loan is the right choice. According to Luthi, personal loans are “a poor choice” when the buyer wishes to purchase a “standard single-family home.” This is because “personal loans typically have much shorter repayment terms and higher interest rates than mortgage loans.”
However, personal loans could help buyers purchase “a very small home or mobile home where the cost is much lower.” In these cases, finding a traditional mortgage broker who is willing to finance your tiny house or off-grid cabin is next to impossible. Opting for a personal loan rather than a traditional mortgage loan could actually make your offer more attractive to the seller. This is because the offer is considered an all cash purchase. Cash buyers are more attractive to sellers because the process is less time-consuming and complex when a buyer is paying cash for a property.
Covering a Down Payment or Closing Costs with a Personal Loan
Another option available to home buyers is to use a personal loan to increase their down payment or cover closing costs. If your dream home was appraised below the purchase price, you could use a personal loan to bridge the gap. Keep in mind that lenders might reject your application if the personal loan you applied for significantly added to your debt. The lender might also reject your application if the loan majorly altered your credit. Furthermore, they could be suspicious if a large amount of cash suddenly ends up in your bank account right before you apply.
#4 Rent or Lease to Own
Fourth on our list of ways to buy a house without a mortgage is to rent or lease to own. In his article “7 Alternatives to a Traditional Mortgage for Buying a Home” for MortgageLoan.com, Dan Rafter explains how this method works. According to Rafer, rent-to-own “can work for both sides if the buyer can come up with a large enough down payment.” With rent-to-own, a portion of the buyer’s monthly rental payment goes “toward credit for buying the home at the end of the contract.” This credit is placed in escrow until the contract’s term has ended. At that time, the buyer can use the money saved towards a down payment on the house.
Of course, there are downsides to a lease-to-own agreement – but not for the buyer. In her article “Alternatives to the Traditional Mortgage” for HGTV, Kara Wahlgren writes that “the seller assumes most of the risk in this agreement.” If you consider this type of alternative financing option, be sure to hire a real estate attorney who can advise you.
#5 Seller Financing
Fifth on our list of alternatives to a traditional mortgage for buying a home is seller financing. As you might imagine, seller financing is a type of contract that allows the buyer to pay monthly payments directly to the seller. Buyers must be wary of this type of arrangement, however, as the current homeowner might not be legally allowed to offer financing. If the seller still carries a mortgage, their broker probably will not allow them to mortgage the house to a new buyer. Alternatively, the mortgage lender might allow the buyer to assume the seller’s existing mortgage.
In her article “Buying a Home With Creative Financing” for The Balance, Elizabeth Weintraub explains how different types of seller financing work. First, Weintraub writes that “some types of mortgages openly advertised that a new buyer could assume the existing owner’s loan.” Loan assumptions were very popular before the 2008 financial crisis. Today, few brokers offer assumable loans to home buyers. This is because of regulatory changes instituted by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Wraparound mortgages are also possible in certain situations, but these are rarely approved by traditional lenders.
Instead, the seller and buyer might agree to a seller-carried mortgage or trust deed. They can do this legally as long as the seller owns the house outright and is no longer paying off a home loan. Sellers can offer buyers this type of financing as long as “the seller did not build the home” and “there is no balloon payment.” The seller must also meet all “criteria established by the Federal Reserve Board.” This means the buyer will owe a reasonable monthly payment and pay interest at a reasonable rate for the entire loan term.
#6 Home Equity Line of Credit or Home Equity Loan
If you already own a home, you might use a home equity loan or a HELOC to finance the purchase of your new property. This method only works if you have owned your home long enough to have built up a significant amount of equity. The property value of the house you want to buy must also be quite a bit less than that of your current home. In his article “How to Get Tiny House Financing” for US News, Ben Luthi explains. Both home equity lines of credit (HELOCs) and home equity loans allow the homeowner to borrow money based on — you guessed it — equity. With a HELOC, money is released in installments while with a loan, the homeowner receives a lump sum of cash. The latter may be referred to as cash out refinancing.
Of course, most lenders “only allow you to borrow up to your combined loan-to-value ratio.” This is “the amount of debt between your first mortgage and home equity loan or HELOC, divided by your home’s fair market value.” If the house you want to buy is worth more than your equity in your home, these will not cover the entire purchase price. You will need a supplement source of financing. The interest rate on both a HELOC and a home equity loan will likely be higher than that of a traditional home loan.
Other Financing Options Available to Homebuyers
You might also be able to finance your alternative property purchase with a loan from your local credit union or community bank. In his Q&A article “Ways to Finance Alternative Homes” for GreenHomeBuilding.com, Senior Vice President of Collegiate Peaks Bank in Salida, Colorado Mark Moore explains. According to Moore, “there are community banks all across the country that do this type of financing.” Some prefer these types of arrangements over traditional lending because “you get the personal service dealing with someone local.” Moore has first-hand knowledge of this. In fact, Moore’s bank is “the only bank in [his] region that will do financing on alternative housing.” Buyers might also consider a short-term hard money loan or crowdfunding – though both are relatively risky ways to finance alternative homes.