Dean Dretske » seller financing

D3TV – Reluctant Negotiating

Dean Dretske — Wed, 30 Jun 2010 19:30:39 +0000

Negotiating as the more reluctant party is a powerful strategy for getting what you want.

As real estate investors, it is easy to be chasing the other party. They are reluctant and this puts us to a disadvantage.

I talk to a lot of people who want to sell their houses. Some of them are motivated to sell and some are curious about what they can get. I only have so much time and money available, so I need to focus my efforts on those that are truly motivated.

I realize now that putting myself in the reluctant position is way to filter out the simply curious. If I take a moment in our conversation to explain a bit about my business model and then ask the seller how their house will fit in that model, then the sellers filter themselves. The motivated will work with me to make it work. The curious will not play.

In my case, I buy houses to rehab/flip or rent. I explain to the seller that I can’t buy at retail prices – I need to fix the house and then sell it and still make money. I also tell them that if I have to give them cash up front, then my costs are higher and I will not be able to pay them as much. I can pay more if I get to make payments over time – either seller financing or delayed payment. Then I ask them how they can adjust to make this work for both of us.

They need to convince me. The simply curious do not care about any of this. They just want their price or they want me to just make an offer. The motivated understand that solving their problem is going to require them to work with me to come up with a solution.

Have you had a similar experience?

Can Ike Buy Now With No Credit?

Dean Dretske — Sun, 02 May 2010 13:13:23 +0000

Yesterday, I saw an interesting question. A seller, who we will call Sally, was talking to an investor, who we will call Ike, about selling her house. Sally is very motivated to sell now, but she has no equity. The house is in good shape and was built a couple of years ago.

Although Ike would like to buy it, his financial picture makes it difficult to borrow from the bank (there could be lots of reasons!). Ike contends that he will be able to borrow the funds needed within 2 years. He wants to buy the property, but is not sure how he can.

There are a couple of solutions that Ike can try.

Subject-To

Ike can purchase the property now, subject to the underlying mortgage. This means that the ownership passes to Ike now, but Sally’s mortgage stays on the property in a superior position. If that mortgage defaults, then its foreclosure can take the property away from Ike. This is often described as ‘taking over Sally’s payments’.

The advantage for Ike is that he does not have to qualify for a loan – he just starts making the payments. Additionally, this mortgage will not show up on Ike’s credit report (it is Sally’s mortgage and stays on her credit report). The advantage for Sally is that she can move on with her life – her house is sold now.

The disadvantages are some risk for each party. They should both be concerned with insurance and with default. Let’s talk about default first.

Sally’s mortgage is likely to have a ‘due on sale’ clause. This means that the lender has the right to ask for a payoff of the balance when the property changes ownership. Lenders started adding this clause back in the 1970’s when interest rates went sky high – the banks wanted to force the new buyer to originate a new loan at the higher rates. However, in the current market, interest rates have been fairly stable and the banks have more foreclosed properties than they should. As long as payments are being made, and there are no other issues that draw too much of the bank’s attention, most banks are not exercising their right to a payoff. Sally and Ike both need to recognize this risk, even if small, since it will destroy this transaction.

The mortgage is likely to have an insurance requirement to protect against the loss of the collateral (the house). Prior to the sale, the insurance shows Sally and the lender as payees in the event of a loss. Changing the insurance to show Ike as a payee will alert the bank of a change of ownership. However, if a loss occurs, then Ike will not get any money if he is not on the insurance. A possible solution is for Sally’s insurance to stay in place and Ike buy additional insurance for his investment.

Wrap-Around Mortgage

This is a type of subject-to transaction. In this case, Sally takes back a mortgage from Ike for the purchase of the house. This new mortgage wraps around Sally’s existing mortgage. In general, the new mortgage balance, interest rate and term are set to be at least equal to the existing mortgage – this way the payment of the new mortgage covers the payment on the existing mortgage. Ike pays his mortgage payment to Sally and she makes her own payment to the existing lender(s). Or Ike sends a check to Sally and to Sally’s lender. Or they may decide to use an escrow service – this gives Ike assurance that the underlying mortgage is being paid.

Insurance is usually kept separate – Sally keeps hers and Ike buys insurance for his part of the investment as it grows.

This method has an extra advantage to Sally – if she tries to borrow money for another house, the new mortgage shows as an asset that balances out the mortgage that continues to show on her credit report. The lender may discount Ike’s payment some, but the bank will still consider that it is reducing the outgoing drain on her finances.

Lease Option

Ike can rent the property with an option to purchase it at a later date. In this case, the deed stays in Sally’s name until the option is exercised. Ike and Sally can set the rent at the market value or any value they choose. Some of the rent can be counted towards the purchase price (usually as part of the down payment).

In the previous methods, if a default happens, Sally would need to foreclose to get back the deed to the property. In this method, she can just evict Ike. Evictions are often quicker and cheaper than foreclosures. If the option is recorded, then some additional action will be required to clear the cloud from the title.

In all three methods, Ike benefits from any appreciation of the property. However, in this method, some of that appreciation can be shifted to Sally by setting a higher purchase price on the option. Basically, let’s say that the current purchase price is $200K, and the option price is set at $220K in 2 years. Now, Sally will get the first 20K of appreciation in those 2 years and Ike will receive the rest of the appreciation as equity.

D3TV – Update on Seller Financing

Dean Dretske — Sat, 13 Feb 2010 13:30:23 +0000

This video contains some new information about seller financing. It includes some background on how often seller financing is being used and new information about how HUD is trying to limit it.

As I mentioned in the video, I want to provide some more information about the SAFE act and how HUD interprets this regarding seller financing. You can read HUD’s complete interpretation here.

HUD is taking comment on their interpretation of the SAFE act through February 16, 2010. Please tell them that they need to exclude all seller financing from the regulation! Click here to submit a comment

What Should You Say in Your Comment
Say what you feel, but say it politely! The message should include that you would like the definitions in the proposed rules to be changed so that private individuals can originate and service loans on properties they personally own. Some ideas from others:

bank loans are not available on some types of properties
the tight lending climate has made bank financing “out of reach” for many
seller financing is an “age old” tradition based on private property rights
these rules would prohibit even partial seller financing – i.e. a “seller second”
according to HUD’s “Residential Finance Survey” in 2001, roughly 40% of all non-farm residential properties in the US are owned free and clear
an estimated 6 million Americans own a property other than their own primary residence
an estimated 4.5% of Americans own three or more properties, many purchased solely as investment properties
40% of non-owner occupied residences are mobile homes which are more difficult to sell with bank financing
approximately 5% of homes in US are for sale or for lease… seller financing may be key to liquidating this inventory

Here is some background:

The Housing and Economic Recovery Act of 2008 (Pub. L. 110–289, approved July 30, 2008) (HERA) constitutes a major new housing law that is designed to assist with the recovery and the revitalization of America’s residential housing market—from modernization of the Federal Housing Administration, to foreclosure prevention, to enhancing consumer protections. The SAFE Act is a key component of HERA designed to improve accountability on the part of loan originators, combat fraud, and enhance consumer protections.

HUD has stated that they read the SAFE act as having a broad requirement for licensing ‘loan originators’. They perceive that a large number of folks will need to be licensed – basically, if they deal with a loan ‘application’, they need to be licensed. In their PDF file, on page 5, they do include the following exclusion:

The SAFE Act encourages States to establish minimum standards for the licensing and registration of State licensed mortgage loan originators and encourages the Conference of State Bank Supervisors (CSBS) and the American Association of Residential Mortgage Regulators (AARMR) to establish and maintain the NMLSR for the residential mortgage industry for the purpose of achieving the following objectives:…

To me, this means that you will need to have a loan originator’s license if you offer seller financing on anything other than an owner occupied residence. You will need a license for vacation homes, vacant land, inherited property (unless you move in), rentals (from single families to fourplexes), etc.

The commercial context implied by the taking of an ‘‘application’’ is also absent where an individual seller provides financing to a buyer pursuant to the sale of the seller’s own residence. The frequency with which a particular seller provides financing is so limited that HUD’s view is that Congress did not intend to require such sellers to obtain loan originator licenses. Accordingly, this rule would provide in § 3400.103(e)(5) that such individuals are not subject to State licensing requirements.

Please add a comment now!

Thanks to the folks at MetroREIT who brought this to my attention.

More on HR 1728

Dean Dretske — Mon, 15 Jun 2009 13:31:50 +0000

Have you called your Senator? LC Kelly sent me a script of a great conversation that she had with one of her Senator’s staffers. Click the link to get and get motivated!

Even though I reported that Senator Dodd is indicating this bill will die in committee, you should still call. The Senator could change his mind, or he could have been misquoted. Also, the folks in Washington DC need to hear from us or they will pretend to know what we think.
Give them a call!

Update on HR 1728

Dean Dretske — Fri, 12 Jun 2009 20:41:03 +0000

Yesterday, I sent out an email to a bunch of folks expressing my concerns about this bill. My broker forwarded my email to a contact who is involved in lobbying for the National Association of Realtors (NAR). I don’t have permission to post the entire response, but I will give the synopsis.

It looks like this bill will die in committee because it is not a high priority item for Senator Dodd (chairman). Dodd’s comments appeared in a May 28th release of Inside Regulatory Strategies and these comments indicate that he believes that the collapse of the sub-prime mortgage market has reduced predatory practices and 1728 is not really needed at this time.

Evidently, the original language in the bill caused real estate agents to be classified as ‘mortgage originators’ as well as ALL sellers who provide seller financing. NAR was involved in getting the current language to both exclude real estate agents and to provide some exclusion for sellers who provide financing (the 1 in 36 month exclusion).

It sounds like NAR supported seller financing, but could not convince the bill writers to provide a complete exclusion.

Disappointed with Bill Bronchick

Dean Dretske — Fri, 12 Jun 2009 04:17:52 +0000

There is quite a bit of email being sent regarding H.R. 1728: Mortgage Reform and Anti-Predatory Lending Act (see it yourself). Wendy Patton describes it here.

Bill Bronchick started a thread over at CRE Online stating that he did not think investors had anything to worry about regarding the bill.

Unfortunately, in the followup thread started by James (James 17:16:43 06/09/09), Bill (William Bronchick 11:43:47 06/11/09) reveals another side with the comment:

Licensing, in my opinion, is a good thing. It weeds out competition so I can charge more for my houses. Getting licensed is not that big a deal, a surety bond only costs a few grand. If you don’t want to be licensed, then have a licensed originator do it for a small fee and charge that to the buyer. In fact, you’ve given me an idea – I will get licensed in my state and charge others $1,000 to draft a few documents!

So we went from ‘no problem’ to a limited number of people with licenses (or an extra expense) being able to use seller financing.

Disappointing!

Seller Financing is BAD – Right?

Dean Dretske — Fri, 27 Mar 2009 05:13:42 +0000

The real answer is ‘it depends’. It depends on the situation and the parties involved in the transaction. Let’s talk about it from the Seller’s perspective and the Buyer’s perspective. We’ll also talk about the investor’s perspective in each of these roles. Remember, I am an investor, not an accountant – please check with your own accountant to confirm how this would apply to your own situation!

For the purposes of our discussion, suppose that a house sells for $150K and the seller takes back $100K as a mortgage as part of the sale (the buyer pays the other $50K as cash to keep this simple). The Seller owned this property free and clear – or owed less than the net cash received. Say the note has an interest rate of 6%, interest only payments (or more), with a balloon payment of the outstanding balance in 15 years. This makes the payments equal $500 per month – assuming only the interest is paid.

Seller – The Good:

The Seller can reduce the amount of tax they pay on the sale. When the Seller ‘takes back paper’ at the sale, that part of the equity of the house is not counted towards their capital gain. As payments come in over time, the principal received in each tax period is considered a capital gain for that tax period. Since our note is interest only payments, the $100K capital gain will be deferred for 15 years. This means that a seller can lower the tax they would need to pay for the house sale – both immediately and possibly as a total over time.

The seller gains an income stream from the note. For the next 15 years, the Seller will have $500 each month to spend – minus ordinary income tax (which will depend on the Sellers financial situation). The Seller actually makes more money for the sale of the house. The total amount this Seller earns is $150K + 15 years * $6000/yr = $240K.

As an investor Seller, this kind of financing can help you stabilize your income stream and result in better returns on your initial investment. Also, by offering seller financing, you may be able to demand a higher sales price at the time of the sale.

Seller – The Bad:

The Seller is still ‘attached’ to the house for the length of time that the note is collateralized by the house. This can be bad if the quality of the house is suspect, or the neighborhood value is declining – as the house decays or the defects are discovered, the security for the note (the house) looses value. This can be countered by requiring a larger down payment, charging a higher interest rate or doing more qualifying of the Buyer. For example, a Buyer who lives in the property is generally more likely to maintain or improve the property while a non-occupying Buyer may not have the same incentive to maintain the property (and the renter likely has no incentive at all).

The Seller may not receive payments on time. Ultimately, the Seller can solve this by foreclosing – which is a process defined by the area where the house is located. For example, in Washington the foreclosure process takes about 4 months while in Oklahoma it averages about 7 months. During this time, the Seller will not receive payments and the house may be vacant or damaged. Again, the Seller can mitigate some of these risks by requiring larger down payments or charging higher interest rates. In our example, the $50K downpayment can mitigate some losses. For instance, if the payments stop and it takes a year to foreclose, the Seller will have lost out on $6K worth of payments. Since the foreclosure process is not free, let’s assume $10K cost (remember that the cost will depend on the location of the property). This means that the Seller still has $34K in cash and now can resell the property. If the Seller can sell the house for more than $116K, then the Seller is still ahead (remember to also add the amount of payments that were received prior to the foreclosure).

As a rehabber, I feel that investor sellers can also mitigate the quality / damage issues more easily than a homeowner. Part of a rehabber’s job is to manage the quality and costs of repairs and to focus our buying in areas of town that are more likely to appreciate.

Buyer – The Good:

It can be easier for a Buyer to qualify for the loan. Mostly because the lender has already qualified the property – the lender/seller agrees on the current value of the property and they have some history with the property’s quality. Additionally, many Sellers do not require as much documentation as an institutional lender would require to qualify the Buyer. Institutional lenders have a process that they use to qualify Buyers – this process is supposed to reduce the risk to the lender (the current economic situation was caused by a loosening of this process). Most sellers who do Seller Financing don’t have a process but instead do just enough to feel comfortable with the Buyer’s promise to pay.

Seller Financing can reduce the amount of money needed to buy a property. Some financing situations can result in zero down payment. For example, in a ‘subject to’ purchase, the seller may loan you all of their equity. For example, the seller may owe $100K on a house that is in disrepair. This house may require $20K of repairs and when fixed up may be worth $200K. A deal could be crafted for a total of $120K where the Buyer takes over payments on the $100K and owes the Seller $20K (to be paid when the Buyer completes repairs and refinances or sells the house).

Seller Financing allows an investor to buy a wider range of properties. An instituitonal lender may not qualify a property if it is in need of some serious rehab work. As an investor Buyer, this means that I may not be able to get a bank to lend me the money needed to buy the property (they may be more accomodating for construction loans, but there are limitations there as well).

Seller Financing allows an investor to hold more properties. Currently, institutional lenders limit the number of loans that a Buyer may have in their name. As an investor Buyer, this limits the number of properties you can own at any one time. The current limit is actually 10, but the qualifying process for more than 4 loans is very difficult – making a practical limit of 4 loans. Most Sellers don’t have similar limitations and Seller financing often does not show on a credit report, so this can be a nice way to avoid this limitation.

Buyer – The Bad:

It can be difficult to find a Seller that is willing to accept Seller Financing. The most common objection I hear is that they just want to cash out. When I dig deeper, often the resistance comes from not really understanding the good and bad aspects (Why did I write this article?!).

I hope this article helped you understand more about Seller Financing. Please share your comments or experiences!