These 2 Little-Understood Strategies Might Actually Help You Buy a Home

Traditional lending is not the only way to buy a home. 

It's easy to understand the frustration. You desperately want (or need) to buy a home, but the interest rate is climbing, home prices remain elevated, inventory is limited, and it seems as though the fates have conspired against you. As a couple who finds ourselves moving frequently, my husband and I have been in your position. Over the years, we've purchased homes in several atypical ways. Here, I'll tell you about one we've used and one that has worked well for other home buyers.

1. Owner financing

Owner financing -- also known as "seller financing" and a slew of other names -- allows buyers to buy a home by paying the current homeowner rather than a traditional mortgage lender.

At this point, I would normally write that the monthly payment is amortized over 30 years, but there's a balloon payment due after five years. In other words, the buyer makes payments to the previous owner for five years, then at the five-year mark, they refinance the house through a traditional lender and pay the former owner off in full. That's how both of our owner-financed deals worked for us.

Marco Bario, a real estate note investor and owner of Porch Swing Funding in Los Angeles, says that's no longer the case. Bario is a fan of owner financing, saying it "helps people get into homes and strengthens communities."

Bario says a properly executed owner-financed deal benefits both the seller and the buyer. Here's how.

Everything is negotiable

The buyer and seller are free to sit down and hammer out the details, including interest rate, loan term, and how large the down payment will be.

Let's say a home seller is 15 years away from retirement. They're already investing in the market and are now looking for a way to earn guaranteed interest. They look around and see that interest rates remain at 2% to 4% on most guaranteed financial products, like money market accounts (MMAs) and certificates of deposit (CDs). They decide that self-financing the sale of their home will bring in a higher fixed rate. 

The potential buyer agrees to pay a 5% down payment and an interest rate of 7% for 15 years. They calculate the monthly payments, including principal, interest, property taxes, and homeowners insurance. The payment fits within the buyer's budget, and both parties are confident that the buyer will be able to keep up with the payments.

Both parties win. The seller receives a higher interest rate than they would otherwise earn, and the buyer owns the home free and clear in 15 years.

To be clear: The term does not necessarily have to be 15 years. The two parties may agree on any length mortgage they choose. Or, they may do it the old-school way by agreeing that a balloon payment will be due in five years. It all depends on what works out best for each party.

Capital gains

Bario points out that owner-financing can make it easier for a seller with a great deal of equity in their home to pay capital gains taxes. Let's say a single seller has a $300,000 gain in their home. According to the IRS, they may qualify to exclude up to $250,000 of that gain from their income. That leaves them with a tax bill on the remaining $50,000.

If they sold the home the traditional way and received the entire $300,000 at closing, their tax bill would be due at tax time. But because they're receiving the proceeds from the home a little at a time, Bario says they will only pay capital gains on the portion of principal they receive in any given year. The fact that they're not receiving the entirety of the proceeds at once can even keep the seller in a lower tax bracket.

2. Lease-option

Often confused with owner-financing, lease-option has a totally different set of rules. However, the details are negotiable.

In a nutshell, here's how lease-option works:

• Before a contract is signed, the homeowner and renter determine which party is responsible for upkeep and repairs to the property. Most agreements split the costs.
• The homeowner may require the tenant to pay an option fee of 2% to 7% of the home's value to hold the option open.
• The homeowner and renter decide on how long the lease will last. At the end of that time, the renter must decide if they are going to buy the house.
• The renter pays a slightly higher rent than fair market value for a set number of years.
• The homeowner deposits part of each month's rent into a special fund that goes toward the down payment.
• At the end of the lease, the renter either buys the home, signs another lease, or moves out.
• If the renter decides against buying the home, they lose the option fee as well as any funds deposited into the down payment fund.  

Not to be confused with lease-purchase

Some homeowners prefer to sell their property through a lease-purchase agreement. Here's how it works:

• While many of the details are the same as a lease-option, a lease-purchase agreement requires the renter to purchase the home at the end of the lease.
• Before the initial contract is signed, the two parties either agree upon a price or agree upon a specific date to have a home appraisal conducted.
• If the renter decides to walk away from the deal at any point, the homeowner can sue them for breach of contract. 
• It's important to know which type of lease contract you're offered before signing on the dotted line. 

It's a tough time out there for home buyers, but having alternative ways to purchase a home just might make it possible.