Investor CPR #3 – Buying Properties with Zero Down Part 1
Variously known as “taking back a mortgage” or “holding the paper,” private financing is often heralded as the easiest and fastest way to sell a house, especially in a slow market.
If you need the proceeds from the sale of one house to purchase another, assisting with financing may not be the way to go. But even in that scenario, it may be worth considering, especially if you can line up an investor to take the note off your hands.
Private financing also could merit some consideration if, say, you’re near retirement and looking for a steady cash flow at a higher rate than you can earn elsewhere. And if you already have another place but are having trouble unloading this one, becoming a lender may prove to be your ticket.
Actually, seller financing is often treated as a last resort, and for good reason. It is, at best, an adventurous tactic that could backfire if your buyer decides not to pay. And almost by definition, buyers who need the seller to carry the first mortgage are not as good a risk as those who can obtain whatever financing they need through normal means.
“That doesn’t mean they’re all deadbeats,” says William Mencarow, who buys and sells seller-held mortgages and publishes “The Paper Source,” a monthly newsletter that services professionals who buy notes from seller-lenders.
“Many are worthy borrowers who just don’t fall into the net of conventional lenders,” says Mencarow. “Some are new to their jobs, others are self-employed and still others are retired or semi-retired with lots of savings, but little in the way of monthly income.”
Another factor coming into play is the implosion in the subprime mortgage market, which is causing lenders to tighten their standards up and down the line. Consequently, a buyer who might have qualified for funding earlier this year may not make it now.
Still, if a conventional lender takes a pass on your would-be buyer and you decide to assume that role, it is incumbent upon you to structure the deal properly — not just as a protection against default, but also in case you decide to sell the note to an investor at a later date.
You may even be able to borrow against the note if the need arises, but only if it is considered sound collateral.
For starters, insist on a substantial down payment — the bigger, the better. Mencarow says a substantial number of notes that people try to sell to him and other investors are “worthless” because they have little or no down payment.
Remember, loans with less than 20 percent down are far more risky, which is why conventional lenders require those borrowing more than 80 percent of the purchase price to pay for insurance that protects the lender from the greater possibility of default.
You probably won’t be able to get this kind of mortgage insurance, so demand the next best thing — a large chunk of change up front. Ten percent is minimum, 20 percent is safer, but if you can get it, more than 20 percent is better.
And we’re talking cash here, not a promissory note, car or jewelry. If you always wanted a cabin cruiser and your buyer offers his 40-footer as a down payment, fine. But remember, it’s tough to convert these things into cash, especially at full value.
At the same time, though, if your buyer has more equity in more valuable real estate, such as an expensive condo at the beach, he should used that property, rather than yours, as collateral, says Bill Broadbent, co-author of the self-published book “Owner Will Carry: How to Take Back a Note or Mortgage Without Being Taken.” .
THE NUMBER ! BEST WAY TO BUY – PERIOD!
How to Buy a House “Subject to”
There are several ways to purchase homes. We have all heard about buying on contract, lease optioning a home, or paying cash. The one way to purchase homes that is not new, but is getting a lot of attention is buying homes “subject to.”
It sounds complicated, and some people even think it’s illegal, but it is the safest, easiest, and, often times, the most profitable way to purchase properties.
When you purchase a home “subject to” it means subject to the existing mortgage that is already in place on the property. The terms of the note that were initially created with the lender stay the same. That includes the name the loan was purchased in.
In other words, you are not assuming the loan. The terms you create with the seller are between the two of you as long as you follow to the letter the terms set up when the loan was conceived.
What about the “due on sale” clause?
The most common question asked by the investors (not the sellers) is: “What about the ‘due on sale’ clause?” This one concern often times keeps numerous investors from purchasing properties using the “subject to” method. Let’s address this right now.
The “due on sale” clause states that the lender has the right to call the entire note due if any of the terms of the initial agreement are not met, such as payments being paid or transfer of the deed without paying off the original loan.
Please understand that the job of a lender is to collect payments. They loan out money at a higher interest rate then they are paying and create their cash flow from the difference on that spread. If a loan were at 8% or 9%, why would a lender call that loan due to have it financed at a lower interest rate? They would be cutting their own profit.
Now, if the payments were not being made, and it was a non-performing loan, they have the right to foreclose in order to recapture their property, so they can sell it again.
Everyone is so worried about what will happen to the buyer or seller of that home if a loan is called due. Let’s look at the other end of it. What would happen to the lender if they called that loan due?
Here’s what happens to the lending institutions if they take back a property. When a lender has taken back a property either by foreclosing or calling a note due, they are “punished” by the Federal government for having that non-performing loan. I am sure you have heard the expression “bad debt”?
If a loan that was taken through a lender is a non-performing loan (meaning the loan is on the “books” of that lender, and payments are not being collected on that loan), then it is considered a bad debt. When this happens the government will not allow eight times that amount to be loaned out by the institution that is holding that bad debt.
In other words, if a bank has $100,000 in bad debts, that means they cannot loan out the amount of $800,000 because the government is punishing them for having that non-performing loan on their “books.”
[Note: One of the disclosures on an FHA-insured loan requires that the lender contact HUD for permission to foreclose a mortgage on a property that was transferred without paying off the loan (subject to). To date, there have been NO reporting cases in which HUD actually gave that permission.]
No personal liability
Let’s try to understand the legal difference between buying a home “subject to” and assuming the loan. When a property owner sells his home “subject to” the existing mortgage, the buyer must make the payments on the mortgage or lose the property by foreclosure. (That is the same as if the seller were not making payments on his loan.)
However, the foreclosure will never show up on the buyer’s credit record because the buyer was not legally obligated to make the mortgage payments on that existing loan. Such a foreclosure on a “subject to” mortgage will adversely affect to seller’s credit record, not the buyer’s.
We are not advocating that you go out and purchase a lot of homes and never make the payments. Remember, you are not legally obligated to make those payments. But you ARE morally obligated. Your word is the most important thing you have. Keep it.
Why would a seller give you the deed?
Why would someone deed you his or her house? The two main reasons we have found are “time” and “debt relief.” If someone is being transferred, divorcing, buying a new home, or financially strapped, you can buy TODAY, so they can move tomorrow.
You can offer that seller instant debt relief and help them out of their situation. At the same time, you can help a buyer who does not, for some reason, have perfect credit and cannot purchase a home using conventional methods.
They can have a pretty house in a pretty neighborhood by a lease option through you. By creating this people helping people concept, you can reap the financial rewards while helping others.
A few examples:
What if the sellers…
Are being transferred? You can buy today. The average time on the market when selling a home is 89 days. That is three months before a home is sold and another 30 to 60 days to close that loan. Time is the most important factor to those sellers. They want to leave knowing their home is taken care of.
What if the sellers…
Is getting divorced? Now they are faced with their income being cut in half. They usually have to downsize. You can buy their home today, so they can start over.
What if the sellers…
Are buying a new home. You can buy today, so they can build tomorrow. AND you can let them live in their house while their new home is being built. No need to move twice or put their belongings in storage. And the advantage to you is you get three months to market that home, so when the seller moves out your tenant buyer moves in!
What if the sellers…
Lost their jobs? They cannot afford to wait for the home to be sold. They need to move now and get debt relief. You can offer them that.
What if the sellers…
Has little or no equity? Did you know there is money in deals like this? By working with the seller and creating a win-win for both of you, you can help them out of their situation.
What if the sellers…
Just want to move to another house? No need for them to wait to find the perfect buyer who has the money and credit to purchase their home. No need to deal with people traipsing through their house or leaving their home while an open house is going on. They deed the home over to you and move on.
Five Ways to Make Money
There are five ways to make money when buying subject to. They are:
Get paid to buy from seller
Non-refundable option consideration from tenant/buyer
Spread between the mortgage payment and the lease payment you receive
Back end profit (The difference between what you paid for the home and what you sell it for)
Tax benefits such as depreciation and interest deductions
Most people do not realize that by purchasing homes “subject to” they are in total control. You own the home; they own they loan. You have the deed to that property.
What happens at closing if you have lease optioned a property or purchased a property on contract and the seller decides they do not want to sell you the home, or they cannot convey clear title?
For starters, it will take legal action against your seller, which takes time. In that period of time, you could lose your tenant/buyer who was going to refinance the home and is now instead probably suing you. When you have the deed to that property, there is no question who is selling it because you OWN the property.
Little Risk, Big Rewards
Purchasing homes “subject to” is a creative, fast, and financially rewarding way to buy homes. It gives you instant ownership, yet you are not legally bound with a lot of loans in your personal name.
We believe with this method of buying homes, you can achieve financial freedom with little risk and great rewards. It takes little money to get started buying homes “subject to,” and remember, when you are able to buy homes with great terms, you can pass on great terms to your tenant/buyer, making it easier and quicker to fill homes, and with a greater financial reward to you.
So step out of the box, and step into this exciting way of acquiring property with little or no risk.
Bonus – RANT. When to use exclusive agreements