Homeownership is often considered the best way for a family to build wealth, and it lies at the heart of the American Dream. However, there are different ways to become a homeowner, and each has its own risks.

Ways to Buy a Home

There are 2 main ways to buy a home: Cash or credit. Most people aren’t able to pay the full purchase price of a home at one time, so the far more common way to purchase a home is through a financing agreement.

There are three main purchasing arrangements for home sales in Arkansas aside from paying in full:

1)     Mortgages

The first arrangement is through a mortgage. Mortgages are loans for the purchase of real property (land with or without a house). In the most basic sense, when you get a mortgage, you sign a contract saying that you will pay a certain amount of money over a period of years (usually 15-30 years) at a certain interest rate. In return, the financial institution agrees to let you keep the house that you bought with the loaned money. Mortgages are usually done through financial institutions like banks or credit unions, but there are also companies that deal specifically with them. Mortgages can be complicated, which is why people like mortgage and loan officers usually help people navigate the ins and outs of buying a home with a mortgage.

To get a mortgage, you generally need to show a good-enough credit score, although what that looks like will depend on who you’re trying to get a mortgage with and what you’re trying to buy. You’ll also usually have to show your income to show that you can afford the payments for the house.

If you find yourself unable to make your regular monthly mortgage payments, mortgage companies may work with you to come up with options, but at the end of the day, it is your responsibility to make the payments. If you aren’t able to, the mortgage company has the option of foreclosing. That’s a process that can give them the ability to take the house back and sell it in order to get back the money that they loaned you to buy the house. Depending on how much you owed on the mortgage, if the mortgage company isn’t able to sell the house for the amount that they loaned you, they may be able to charge you for the deficiency or the difference between what you owed and what they could sell it for.

2)     Escrow Contracts

The second option is much less common. It’s called an escrow contract. In that arrangement, you’re usually working with the party you’re trying to buy the house from and then a third party called an “escrow agent.”

In this arrangement, you and the seller agree on a purchase price, how often you make payments, and other terms for you to pay them, and then they provide a deed for the house to the escrow agent. You make the payments as agreed on, and then once the full purchase price is paid, the escrow agent is supposed to give you the deed. Escrow in this sense is different from escrow in a mortgage.

3)     Rent-to-own or Owner Finance

The third option is very similar to number 2, except there is no escrow agent. This kind of home sale contract is relatively common, though not as common as a mortgage.

For this option, you buy directly from the current owner of the property. This can be done in a similar way to a mortgage, where the seller holds what’s called a “security interest” that allows them to foreclose if you don’t pay. It can also be done in what’s called an “executory contract” or a rent-to-own (RTO) or lease-to-own (LTO) agreement.  

For these contracts, you and the seller have a purchase price that you agree on, the repayment terms, including the amount, how often, any interest they will collect, and what happens if you don’t pay. Once the full purchase price is paid, then the seller will give you the deed to the property and you will own it. Or they may give you the deed at the time you enter the agreement and then require you to provide them a “promissory note” and a “quit claim deed”. This makes sure you pay them, and if you don’t, they get to take the house back.

For these kinds of contracts, unless the contract says differently, you pay a monthly payment just like you would for rent or for a mortgage payment. However, these contracts can be trickier than a mortgage due to what’s called a “forfeiture clause”. This part of the contract can say that if you don’t make a payment on time or within the late period allowed by the contract, then the seller can cancel the sale and keep all of the money that you’ve paid them already and call it rent. Then, they can file an unlawful detainer (eviction) against you as if you didn’t pay rent.

This last kind of home sale contract is usually appealing to people who feel like they won’t qualify for a mortgage based on poor credit, low income, or another reason.

With all three of these options, you could be required to file something with the county to show that you are buying the property.

Risks and Rewards

Each of these kinds of home sales carries its own risks and benefits.

Generally, mortgages carry more benefits at lower risk since financial institutions have to comply with all kinds of government regulations. Mortgage companies also have systems in place that may help you out if you fall behind on payments or have other issues. They are also subject to bankruptcy laws, so if you do fall behind, you may be able to catch up through bankruptcy while being protected from foreclosure. However, because they are often large companies with a lot of mortgages to take care of, there may be mistakes in the administration of your mortgage. That means that they may miss a payment that you’ve made, mistakenly refer you for foreclosure, or something else.

It is important to try to keep all of your paperwork for your mortgage. That includes the contract, receipts for payments, etc.

Escrow and rent-to-own have very similar risks and benefits. They usually don’t require you to have good credit, so they can be more accessible for people with lower income, less credit history, or people who have taken a hit on their credit score that they haven’t been able to recover from. Generally, you are entering the contract with a private person or small business, so you are usually dealing with people who live in the same area as you.

However, when you aren’t able to make your payments, you may have fewer options to help you get back on track than you would with a mortgage. These kinds of contracts also stop you from building equity (the amount of the home you own based on how much you’ve already paid for), so you may not be able to take out a loan using your home equity as collateral. It can also mean that you don’t get to actually claim ownership of the home until it’s all paid for. This means that you may pay for a home for 20 years and then, if you fall behind on payments, lose the home altogether.

What to Do if You Do Want to Buy a Home

If you are interested in homeownership, you should talk to professionals first to make sure that you understand all of your options.

You can start by talking to a HUD-certified Housing Counselor. These are certified professionals that can help you navigate the home-buying process and determine what the best option for you is. You can search for a HUD-certified housing counselor at: https://hudgov-answers.force.com/housingcounseling/s/

If you have already talked to a housing counselor, then you should follow up by discussing options with a licensed real estate agent.

And last, if you have any questions or concerns about a contract, consult with a practicing attorney before entering into any contract or agreement that you are worried about. Or, if you’ve already entered a contract and you are now running into issues, consult with an attorney to find out what your options may be.

The Center for Arkansas Legal Services can assist eligible individuals with addressing housing and mortgage issues and provide other information to tenants and buyers regarding their rights. If you need legal help with this issue, you can apply for services at www.ArkansasLegal.org (the button is in the top right-hand corner) or call our helpline at 501-376-3423.

AUTHOR: KALE ANDERSON, STAFF ATTORNEY FOR THE CENTER FOR ARKANSAS LEGAL SERVICES