How do you structure a deal if you can’t find outside financing? I’ve used a number of creative financing options as a buyer, a seller, or as a deal facilitator for others.
Please note: Different states may have different terminologies or methods for these financing instruments. Check with your local legal and accounting advisers as well as your local escrow and title companies before beginning the process.
These are some of my favorite creative financing methods:
- “Subject To”
- AITDs (All Inclusive Deeds of Trust)
- Land Contracts
A “subject to” purchase is when you purchase a home (or other property type) subject to the seller’s existing mortgage.
Usually, you do not formally qualify for the existing loan. The seller gives you a Grant or Quitclaim Deed in exchange for some type of consideration (i.e. money, a note, or other assets). Your “earnest money” may be as little as $10.
The borrower may be an individual, a corporation, an LLC, or some other type of entity. The borrower essentially takes over the payments of the existing mortgage. The seller still has the loan liability until this underlying loan is either paid off in full or refinanced at a later date.
The lender may have the option to call the loan all due in payable for a violation of the “alienation” or “acceleration” clauses in the existing mortgage. Lenders require that buyers formally qualify for their mortgages, and they frown upon other buyers just “taking over” the payments.
However, it is very rare for a lender to actually foreclose on a new property owner who just took over the loan payments. But it can be a very real possibility depending upon the motivation of the lender or loan servicing company.
There are so many non-performing loans these days, most lenders are just happy to receive a monthly payment from anyone. At worst, they may just send out a few warning letters to the new property owner requesting that they refinance the loan.
If you purchase property this way, make sure you get a clear title insurance policy from a national title insurance company. There may be tax, loan, or other liens secured against the property that you (or the seller) may not know anything about, which might reduce the property’s overall value.
All Inclusive Deeds of Trust (AITDs)
An AITD is a “wrap” of an underlying mortgage. I have structured many AITDs (recorded instruments) and Land Contracts (or Contracts for Deed – unrecorded financial and deed document transfers) over the years. A “wrap” is essentially the creation of a new mortgage which “wraps” around an underlying mortgage.
For example, I may have a 1st mortgage loan in the amount of $70,000. The interest rate may be 7%, the loan term may be 30 years, and the approximate monthly principal and interest payment may be $465 per month.
I may find a buyer who cannot qualify for a loan from his local bank. He offers me $110,000 for my same home with the following terms:
- $10,000 down payment
- $100,000 wraparound mortgage
- New Wraparound Interest Rate: 9.9%
- Loan Term: amortized over 30 years, due in 7 years
- New Wrap Monthly Payments: approximately $870 per month
As the seller of the home, I receive $10,000 in the form of a down payment (excluding closing costs). In addition, I am earning approximately $405 per month in net proceeds as the different between the underlying $465 bank mortgage in First lien position, and the new wrap mortgage payment in the amount of $870 per month.
The AITD buyer also must refinance or pay me off in full within 7 years of the purchase date. When he or she pays me off, I will also gain the difference between the underlying principal amount of the First mortgage (originally $70,000) and the new Wraparound Mortgage amount of $100,000 (approximately $30,000).
Please keep in mind that the underlying $70,000 mortgage amount will amortize or pay off faster than the new Wraparound mortgage amount since it is has a much lower interest rate (7% vs. 9.9%).
There are installment sale tax benefits to the seller of a wraparound mortgage that your tax adviser can explain to you. It’s typically much easier to sell a home with a no qualifying wraparound mortgage than with a conventional bank loan, regardless of interest rate differences.
When an investor structures a large number of AITDs or Contracts for Deeds, they can ask a title insurance company to collect all the wrap payments, pay the underlying First mortgage still in his name (or someone else’s name), and credit his bank account with the net difference each month.
Additionally, the title insurance company may issue the corresponding 1098 and 1099 tax forms and help maintain a consistent track record of the monthly and annual numbers. Some title insurance companies or accounting firms perform this service for as low as $10 per month.
Land Contract or Contract for Deed
Land Contract financial and sales agreements are similar to the AITDs listed above, and they can be used for many different types of properties besides just land. The main difference is that the buyer does not receive the formal recorded Grant or Quitclaim Deed until the wrap is paid off in full or refinanced. The Contract Payer (the buyer) has “equitable title” but not “legal title” in the property in many states.
Typically, a third party like an Escrow, Title Company, or an Attorney will hold the Grant Deed for both parties until the Land Contract is paid in full. Once the Contract Payer pays off the Contract for Deed, then the Grant Deed is recorded in his name at the local county recorder’s office.
Land Contracts (or Contracts for Deeds) can be risky for both the buyer and seller as there can be “clouds on title” that affect the property’s value. For example, the seller may have future tax liens, which can later be recorded against the same property.
Many property owners hold recorded or unrecorded ownership interests in creatively seller financed homes under LLCs or Corporations. Some non-conventional lenders will allow property owners to refinance into the name of an LLC or Corporation after the borrower provides proof of ownership interests in the separate financial or legal entities as well as solid proof of an on-time mortgage payment histories, such as copies of the last year or two’s cancelled mortgage checks.
Get Professional Advice
Please get several legal, financial, and accounting opinions from your local advisers before you decide to try either an AITD or a Land Contract.
While there are risks involved with just about any type of real estate transaction, an investor who does his “homework” ahead of time will soon learn that creative seller financed home sales are some of the easiest and most profitable real estate investment options out there today!
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