Should I get a mortgage with bad credit from the seller?

By Gina Pogol
Mortgage Credit Problems Columnist

Dear Gina, I have bad credit but want to buy a house. I saw some websites that have lists of owner-financed properties in my area. Is owner financing a good way to get a bad credit home loan? - Linda, Idaho

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Dear Linda,

Owner financing can be a nice way to finance a home when you have bad credit. It can also cost you everything you have if you aren't careful. Owner financing can be a way for those who don't need to completely cash out of their property to increase the pool of potential buyers -- a perfectly legitimate marketing strategy. However, some people use seller financing or lease options to sell their property ... and sell it again, and sell it again.

Bad credit seller mortgage financing: Don't pay more

Some sellers use owner financing to get an inflated price for their homes. In an article touting the advantages of seller financing, Kalinda Rose Stevenson, Ph.D., says that if one seller had been willing to carry a note, he could have sold a home that was "clearly overpriced" at $950,000 for $225,000 more than its true value of $725,000 -- of course the flip side is that a couple hundred thousand would have been picked from the buyer's pocket. Getting more for the property -- perhaps more than it's worth -- is a big factor in some sellers' decision to carry the note on their property.

Mortgage lenders require appraisals

Mortgage lenders require the property value to be supported by an independent appraisal, and you should too. Select the appraiser yourself; don't allow a real estate agent, the seller or anyone else who stands to make money from the transaction to hire or pay the appraiser. Know what the home is worth before committing to buy it.

Get help with your purchase agreement

Real estate lawyer David Clurman advises that ''a seller's mortgage should be reviewed much more carefully than an ordinary bank mortgage.'' While most mortgage lenders and real estate agents use standard forms (typically the Fannie Mae 1003), mortgages and purchase agreements from private sellers could contain very unfavorable terms for the buyer. For example, late fees could kick in the day after your payment is due and may be quite expensive. Seller-drawn agreements can make it very easy for sellers to take back leased properties or foreclose on purchases.

Don't be a victim

One other strategy of "serial sellers" is to lend to people under financial pressure -- that is, buyers with bad credit. The idea is that the seller pockets a significant down payment (or lease option payment) and/or several thousand in mortgage points and fees, saddles the buyer with high mortgage rates or lease option payments, and forecloses or evicts as soon as possible. Before having a real estate attorney vet the purchase and mortgage paperwork, check with your county recorder's office and see if there are previous sales or lease options on the property. Make sure you can afford the payment -- if it's significantly higher than your current housing expense, you should probably pass.

Check with bad credit lenders first

You might be able to secure financing for people with credit problems by checking this site. Bad credit mortgage lenders have to abide by a lot of laws that protect borrowers -- private lenders do not. Before subjecting yourself to the pitfalls of owner financing, see if you can't find a home loan from a licensed mortgage lender.

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