November 26, 2022

Millions of American home shoppers have taken on risky and generally more costly alternative financing, in part because even creditworthy buyers may have trouble finding traditional mortgages for lower-priced properties, new research suggests.

One in 15 current home borrowers, or about seven million Americans, uses alternative financing, including arrangements in which they make payments directly to the seller instead of to a lender, according to recent survey by the Pew Charitable Trusts. The survey also found that the use of alternative financing was highest among Hispanic borrowers and people with annual income below $50,000.

The financing arrangements often lack consumer protections available with traditional home loans and are lightly regulated by a patchwork of federal and state rules, said Tara Roche, manager of Pew’s home financing project. Adding to buyer confusion, the arrangements may have different names in different parts of the country.

The size of the alternative financing market is murky because there is no systematic national collection of data about such purchases, Ms. Roche said. In many states, the agreements don’t have to be recorded in a public registry, as conventional mortgage purchases do.

When the home financing project conducted a national survey of about 5,000 adults in June, the number who said they had used alternative financing was much higher than it had expected.

“We were very surprised to see that 36 million people have used alternative financing, spread out across the United States,” Ms. Roche said.

Most Americans need mortgages to help pay for their homes. But in some cases, people — or the homes they want to buy — may not qualify for a conventional mortgage. In other instances, some eligible borrowers may be pushed to alternative financing because it’s hard to find traditional mortgages for amounts below $150,000, according to Pew. Lenders have little incentive to make small loans, because larger loans are more profitable.

Pew found the most common type of alternative financing to be personal property or “chattel” loans, which are often used to buy manufactured homes (formerly called mobile homes). The loans are akin to traditional mortgages but often carry much higher interest rates and shorter terms, resulting in higher monthly payments and more interest paid over the life of the loan when compared with manufactured-home borrowers who obtain mortgages. Because the loans aren’t considered traditional mortgages, they aren’t subject to foreclosure rules, and lenders often can repossess the homes quickly if a borrower falls behind.

With chattel loans, the borrower typically buys the structure but rents the land beneath it. Landowners — increasingly, professional investors — can raise the rent to levels the borrower cannot afford, leading to a default.

In one common type of seller-financed agreement, called a “contract for deed” or a land contract, the seller extends credit directly to the buyer, who typically does not receive the deed to the property until the loan is paid. Because buyers lack proof of ownership, their payments may not build equity in the property, and it may not be clear who is responsible for taxes and repairs. The loans typically lack foreclosure protections, so buyers who fall behind in payments may risk eviction and loss of their investment if they miss a payment.

“They come with very high risk,” said Mike Calhoun, president of the Center for Responsible Lending. “They are almost always a horrible idea.”

Nontraditional financing needs further scrutiny by policymakers, Mr. Calhoun said, particularly because buyers may be increasingly forced to consider it as housing becomes less affordable.

Home prices have surged because of a lack of available properties, and now mortgage rates are rising. The average interest rate on a 30-year fixed-rate home loan reached 5 percent in mid-April, the highest in more than a decade. Rising rates and prices combined with tight inventory “are making the pursuit of homeownership the most expensive in a generation,” the mortgage finance giant Freddie Mac said.

Manufactured homes offer a large pool of unsubsidized affordable housing, but risky financing and challenges with land ownership can undermine their potential as a solution to the housing shortage, Ms. Roche said.

The industry needs “more careful oversight and regulation,” Mr. Calhoun said, if it is to be a viable “mainstream” alternative.

Here are some questions and answers about alternative home financing:

Pew said more research was needed to quantify how often home buyers succeeded in securing title to their homes when using nontraditional financing. In a separate report, Pew said that “virtually nothing is known about the share of families that actually end up owning their homes when using these agreements.” But it also said available evidence “clearly indicates frequent poor outcomes.” A 2012 study that focused on low-income settlements in Texas, for instance, found that fewer than 20 percent of contract-for-deed buyers made the transition to a deed.

If you are considering buying with some sort of alternative financing, always research other options, Mr. Calhoun said. Some buyers may feel intimidated by seeking financing at a traditional lender, but it’s best to start there, he said: “Check with your bank or credit union.”

Purchases that include both a manufactured home and the land beneath it may be eligible for conventional mortgages, Mr. Calhoun noted. “People need to comparison shop,” he said.

(More than a quarter of personal-property loan borrowers own the land under their homes and could be eligible for mortgages, Pew’s report said, although they may have to jump through legal hoops in some states.)

Sarah Bolling Mancini, a lawyer with the National Consumer Law Center, said arrangements like land contracts carried significant risks. One way borrowers can protect themselves, she said, is to file an affidavit, or a copy of the financing contract, with a local registry of deeds or county clerk’s office to document their financial interest in the property. People can do this themselves or seek low-cost or free legal help. The federal government offers an online search tool.

While many people use the terms interchangeably, manufactured homes are factory-built houses made after mid-1976 that comply with construction and safety standards set by the Department of Housing and Urban Development, according to the Consumer Financial Protection Bureau. Mobile homes were built before 1976. The industry produces about 90,000 factory-built homes a year, the Manufactured Housing Institute, a trade group, says.