3.4 Million Americans Using Non-Mortgage Financing to Buy Their Homes. What Are the Risks?

Pew recently published a study of alternative financing as a route to homeownership. And How Americans Pay for Their Homes revealed that 3.4 million people were using unregulated alternatives to mortgages. The report said:

"The arrangements were most common among buyers of low-cost homes, rural properties, manufactured homes, and units in multifamily buildings. For some of these buyers, alternative financing is a lifeline that enables them to live in the home and neighborhood of their choice, even when they can’t get a mortgage."

The study went on to say that some never end up owning their homes. But they are still on the hook for complex contract terms that can lead to financial harm.

What Is 'Alternative Financing?'

Alternative financing can include

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

4% of Homes Have Alternative Financing

It's worth getting alternative financing into perspective. Pew reckons there are about 83.4 million owner-occupied homes in America. Of those:

• 47 million have a mortgage
• 3.4 million have alternative financing (about 4%)
• 32 million own their homes outright

So, alternative financing is a minority issue. And, you must hope, many who use it are in benign arrangements. But that still leaves millions of Americans potentially facing the "serious financial harm" that Pew warns of.

Why People Turn to Alternative Financing

Pew identifies a few reasons why would-be homeowners choose alternative financing. But, overwhelmingly, it's because they have no choice.

Small Mortgages

Often, the homes they're buying have low price tags. And mortgage lenders are reluctant to fund these because the costs of originating (setting up) a mortgage are so high.

It's unusual to make an acceptable profit on a home loan with an opening balance of $150,000 or less. And many struggle to make $200,000 mortgages pay adequately.

Rural Locations

This disproportionately affects rural homes. The survey found 9.8% of rural borrowers were using alternative financing in 2021, compared with 6.1% of urban borrowers.

Pew suggests rural homes tend to be more rundown than urban ones, making many less costly but unmortgageable. And people in rural areas are more likely to have low or no credit scores than their city counterparts. This score gap was borne out by a 2023 study by a federal regulator, the Consumer Financial Protection Bureau.

Manufactured Homes

Another factor is that many want to use mortgages to purchase manufactured homes, once called mobile homes or trailers. These are only mortgageable if the borrower owns the land on which it sits and the home meets certain technical standards.

But there is another requirement. The home must be designated as real estate rather than personal property, meaning you pay property taxes on it rather than vehicle taxes.

It's not hard for compliant homes to change from one designation to another, but Pew cites Census Bureau data that show 75% of all manufactured homes are currently shipped as personal property. How many people know how easy it is to switch the designation to real estate?

Condos and Duplexes

Roughly 23% of borrowers in condos and duplexes turned to alternative financing, compared with just 3% of those in single-family homes, says Pew.

The main obstacle here is that lenders lack the resources to fully audit homeowners' associations' books. Some buildings are well-funded and have plenty of money to pay for virtually any unscheduled repairs. But others are liable to topple over at the first sign of problems, leaving owners to pick up the bills for fixing unexpected structural issues.

Also, it's often more costly to originate a loan on a condo because lenders' automated underwriting systems sometimes can't cope with all the variables. Manual underwriting takes more time and money, deterring some from taking on these loans.

Possible Fixes

All these factors tend to drive borrowers into the hands of alternative lenders, some of which are predatory and exploit wannabe homeowners. Pew suggests a way forward that could keep more borrowers within the relative safety of the highly regulated mortgage industry:

"To better support Americans on their path to homeownership, federal policymakers should focus on areas where the current mortgage market is falling short. In parts of the housing market where alternative financing is common, government officials should consider strategies that expand the supply of mortgages. They should also encourage the design of new products and adoption of policies that can help to meet consumer demand in these markets while improving protections for buyers using alternative financing."