The Up (And Down) Side Of Creative Fincancing
Back in 1993 when I began my real estate career, we had many options to sell a home (few of which were conventional). At the time interest rates were higher than FHA limits would allow. Many of the best houses offered for sale were upside down in value. And, selling a house was a real challenge.
We had a number of alternative methods to overcome the hurdles we had to cross all effective. And, all of them had risk or benefits for the principals involved in the transaction.
First there was the wrap around (All Inclusive Trust Deed): This simply stated allowed the buyer to take title to the loan while the sellers name remained on the loan for the term of the contract. It worked something like this. Your home might have been worth ninety thousand dollars. But you might have owed one hundred and twenty five. The buyer with the full understanding of the value might offer the seller five thousand in cash in return for being deeded to the house.
The upside for the buyer in this scenario is simple, no credit report or loan qualification. And, most importantly no risk to credit if he is unable to make the payment. Usually these arrangements were made with a specific term in which the buyer had to refinance the home and take the seller off of the loan. And, the payments typically were made to a third party who in return paid the mortgage.
The risk for the seller in this type of transaction can be huge or very nominal depending on how the arrangement is written. In the event the buyer defaults, the seller has lien rights and can in fact foreclose just as any other lien holder. He must however, cure any default of the senior lien holder.
That being said, let’s say the seller finds himself in a life changing event that requires that he either lose the house and destroy his credit. Or, sell via this method and have the opportunity to save his credit rating this option can be very beneficial with the right buyer. Because, the sellers credit is maintained or in some cases improved once the payment is paid in a timely manner over a protracted period of time.
Another option was the “Land Contract”. In this transaction, the buyer in return for some consideration took “equitable” title to the property. He has all the rights to use the property in any fashion he deems fit so long as it does not conflict with zoning regulations. What he has the right to claim the tax deduction for interest paid against this purchase. What he does not have is the right to further encumber the property without first paying off the first lien holder and the seller.
This is very similar in concept to the Cal Vet program that many veterans have used to purchase homes for generations. And, it is a secure method of sale with few risk for either buyer or seller.
In order to protect both buyer and seller, the seller usually will execute a grant deed in favor of the buyer which is held by a neutral third party until such time as the buyer is in a position to pay of the obligation. At which time the deed is transferred to the buyer and recorded. In this type of transaction the neutral third party also would be expected (for a fee) to collect all payments from the buyer. And, make all payments to the seller and the lien holder.
This is a brief look at Creative Financing 101. Next week we will take a look at other alternatives such as sellers carrying seconds, and short sales.
As a caution I would tell you that most loans written in the last few years have a clause in them that says simply that if the property owner at any time conveys his interest in the home to another party, the lender may call for the loan to be paid in full on demand. This is called an acceleration clause. And, while it is rarely (if ever) enforced on a performing loan, you must be aware of the possibility of this occurring should you enter into any type of creative financing arrangement.