Holding a mortgage: Defined and explained

Many borrowers opt to purchase their home with one of the many types of mortgages available on the market. But due to the lender requirements, that’s not always a viable option. If your financial situation is presenting challenges in obtaining home financing through a lender, a holding mortgage could be worth pursuing.

Holding a mortgage is a type of seller financing arrangement in which the homeowner acts as the lender for the home buyer. This guide explores what holding a mortgage means and how it may help home shoppers who don’t qualify for a traditional mortgage option.

What is a holding mortgage?

Holding a mortgage, sometimes also referred to as an installment sale or a holding mortgage, involves a seller financing agreement. When the seller agrees to holding a mortgage, the homeowner acts as the lender to the home buyer. In other words, the seller offers a loan to finance the home buyer’s purchase.

Once both parties commit to holding a mortgage, the buyer makes monthly payments to the seller. During the repayment process, the seller holds the property title until the buyer pays off the loan. Generally, holding a mortgage is a short-term financing solution.

Notably, a holding mortgage is a type of nonconforming loan, which means it doesn’t meet the Fannie Mae and Freddie Mac standards for a home purchase. For buyers without the financial credentials to qualify for the standards of a conforming loan, holding loans represents a possible pathway to homeownership.

Features of a holding mortgage

As an untraditional financing solution, the details of a holding mortgage can change from situation to situation. After all, the buyer and seller agreement includes details sorted out on a case-by-case basis.

But, generally, holding mortgages are short-term financing solutions. These loans might not be amortized, which means that your monthly payment might not cover enough to repay the loan with interest by the end of the term. With that, holding mortgage borrowers often face balloon payments, or a large lump sum payment, due at the end of the loan term.

Throughout the loan term, the borrower will make payments to the seller. After the loan is paid off, the title transfer to the borrower proceeds.

The table below breaks down some of the key features associated with holding mortgages:

Pros and cons of holding a mortgage for a buyer: At a glance

Every financial transaction comes with advantages and disadvantages to consider. As the buyer, it’s especially important to weigh out the pros and cons before moving forward.

The table below highlights the pros and cons of holding a mortgage as a buyer.

Pros

• Accelerates home buying process: If the seller is willing to facilitate financing, this might eliminate some of the steps required by traditional mortgage lenders. The streamlined process can finalize the home purchase sooner.
• Lenient borrower requirements possible: Seller financing requirements vary from seller to seller. But, generally, sellers willing to offer financing work with lenient borrower requirements. For example, they might accept a less-than-perfect credit score or a higher debt-to-income (DTI) ratio.
• Lower monthly payments: The seller might not require a large monthly payment. But this could result in a significant balloon payment at the end of the loan term.

Cons

• Higher interest rates: Sellers may offer a holding mortgage when the buyer can’t qualify for a traditional mortgage, which usually means more risk for the lender. Generally, sellers compensate for this risk by charging a higher interest rate.
• Risk of balloon payments: In some cases, a holding mortgage involves a balloon payment at the end of the loan term.
• Alienation clauses: Sellers may include an alienation clause in the holding mortgage agreement, which allows them to demand the mortgage balance be paid off in full immediately. While they might not enact this clause, it could throw a wrench in your plans.

Pros and cons of holding a mortgage for a seller: At a glance

Holding a mortgage comes with advantages and disadvantages for the seller too. Before jumping into this major financial transaction, weigh out the pros and cons.

The table below highlights the pros and cons of a holding mortgage as a seller.

Pros

• Reliable passive income: Sellers can enjoy a passive income stream, which can be worthwhile for many.
• Eligibility for mortgage notes: Obtaining mortgage notes through holding mortgages offers a way for sellers to tap into a real estate investing opportunity. Sellers retain the property title until the buyer pays off the loan, which gives sellers an income generation opportunity.
• Ability to sell property quicker: When selling in a tough market, enticing buyers through a seller financing solution could lead to a faster closing process.

Cons

• Higher risk of default: If providing a loan to a buyer who cannot qualify for traditional financing, the risk of the borrower defaulting on the loan is relatively high.
• Risk of expensive repair costs: If the buyer defaults on the loan and the seller regains control of the property, the seller may face significant repair costs due to damage left behind by the buyer.
• Foreclosure could be expensive: Although the house secures the debt, regaining control if the buyer cannot keep up with the payments can get expensive. On average, foreclosing may cost over $75,000.

FAQ

If you have more questions about a holding mortgage, the following answers may help.

How do I hold a mortgage for a family member?

If you want to hold a mortgage for a family member, you could offer them seller financing on the property in question. For example, let’s say you are selling your child a home you own outright, you could use a holding mortgage seller financing agreement in which the child would make mortgage payments to you.

What are the tax benefits of holding a mortgage?

If you hold a mortgage, you’ll receive ongoing income from the buyers instead of an upfront cash payment. Depending on the situation, tax benefits may include spreading out the capital gains tax liabilities over several years.

Do you pay capital gains if you hold a mortgage?

Whether you pay capital gains when holding a mortgage varies based on the situation. Home sellers may qualify for the home sale tax exclusion of up to $250,000 for individuals or $500,000 for spouses filing joint tax returns if they lived in the home for at least 2 of the last 5 years.

The bottom line: A mortgage hold carries certain risks

A holding mortgage can be a viable option for home buyers who don’t qualify for a traditional mortgage, and it can be an opportunity for the seller to earn additional income.

Buyers should know that holding mortgages usually have a higher interest rate, increasing their overall cost. These mortgages also come with additional liability for the seller, who may have to initiate foreclosure or assume responsibility for the state of the property if the buyer defaults on their payments.

Before committing to a holding mortgage, take the time to explore all of your traditional financing options with Rocket Mortgage®.