It just may be your lucky day. You’re a bit short on cash to purchase your first home. But you find a seller who owes more on his mortgage than the property is worth (due to refinancing into a 125% loan two years ago). He says you can “have the house” by assuming the loan. And if you’ll front his closing costs for him, he’ll pay you back in the future.

Lucky? Not! While there’s nothing wrong with a little creative financing, there’s plenty wrong with this highly-leveraged approach. Even if it’s the only way you can swing a purchase now, the seller’s dug himself into a hole that you’d be wise to avoid.

First, most loans like the seller’s are not assumable and are required to be paid in full when the property is sold. Even if it could be assumed, the interest rate may be higher than average and it could be quite a while until appreciation equals or exceeds the amount of debt against the property.

This is particularly true since the interest portion of the mortgage payment is heftier in the early years of the loan (another reason why seller hadn’t grown substantial equity). If you’d need to sell before the market value equals the debt (which could take years to reach), you could be faced with the very same problem the seller has---few options and few buyers.

Second, once you purchase the house, it’s doubtful that the seller would have much incentive to pay you back for the money you’ve fronted on his behalf. And unless he’s willing to give you an equity position (like a second mortgage) in any other real estate he owns or is purchasing, you’d be forced to take him to court to enforce payment. This could be a costly and potentially futile proposition especially if he’s moving out of the area.

If you have enough to cover closing costs, talk to a mortgage lender about what it would take to purchase using one of the home affordability low-down payment programs or an FHA (Federal Housing Administration) loan.

Fannie Mae (in the secondary market) even has a conventional low-down payment loan called the Flexible 97 that allows you to fund the three percent down payment required using your credit card. Although it’s also a form of creative financing, it has fewer far-reaching effects than what you’re considering by taking on the seller’s problems.

Purchasing your first home is financially stressful even in the best scenarios. Don’t risk a financial misstep that could ruin your credit or even cost you a foreclosure. It’s worth the wait to start off with a more promising financial picture than the one painted by an over-leveraged, in-debt seller.

Published: October 27, 2000

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Julie Garton-Good, DREI “The Frugal HomeOwner™” As a syndicated newspaper columnist, author and international speaker, Julie Garton-Good DREI, C-CREC™, is called “America’s Home Affordability Expert”, addressing more than 25,000 persons annually on topics of real estate industry trends and home affordability. She is the author of five real estate books and is the sole two-time recipient of the international "Real Estate Educator of the Year" award from the Real Estate Educators Association. In 1997, The National Association of Realtors® nominated Julie as one of the fifty most influential people in the real estate industry. She shared the list with only three other women.