Single Family Homes - The No Risk Investment! - Part 8 Could you buy a home with the lower interest rate, owner/occupant loan,
live in it for a few months, then move and rent it? A few investors do this
and have no problem as long as they are always on time with the mortgage
payment.
You have to impress on the new tenants that it is vital that they notify you
of any mail delivered to the house with your name on it. You will get letters
from the lender now and again. You want to be sure the letters get into your
hands in case the loan is sold and you must send payments to a new address.
Sometimes the amount of the monthly payment will change because of an
adjustment in insurance rates or an increase in property taxes. Better yet,
contact the lender and ask that all mail be sent to a post office box.
Perhaps at this point I should clarify the role a mortgage broker plays in
real estate financing. If you seek a mortgage loan from a bank or other large
financial institution they be lending their own money. They will have their
own standard interest rates and fees.
A mortgage broker is an independent agent who places loans for dozens of
money sources. The funds could come from insurance companies, retirement
funds, investment bankers, etc. The mortgage broker gathers all the
information concerning the potential loan; executes all of the paperwork and
puts together a package of documents he will submit to one of the sources of
funds for their approval. For doing this he gets a fee from you and also
something from the lender. Good mortgage brokers are very open about the
costs of a loan. Just ask and they will tell you.
A good broker can fit you to the best source of funds. He even knows
how to cut a corner or two when necessary. Nothing dishonest, he is just
acting on his years of experience.
Very often the original lender will sell your loan to another financial
institution. After a time that institution may again sell the loan. Lenders
usually assign the collection and management of your loan to companies that
specialize in that area of the business. That’s called “servicing the loan”.
6-
8
After you have acquired a number of properties with new financing your
credit report will show you are top heavy with debt. At that point you will
find it difficult if not impossible to get conventional financing. From the
lenders viewpoint you have become a high-risk borrower.
Without new financing you can profit by controlling property through
leases, options and other techniques. More on that later in this manual.
Is It Practical?
The primary theme of this manual is to present practical techniques.
Ideas that you and I can actually put into practice in our every day worlds.
The material you might buy from one of the TV real estate gurus has some
far out plans. They’ll tell you that you can “walk the equity” from one
property to another, do double closings and other nifty tricks.
Yes you can do those things, but are they really useful tools?
Certainly not in your first years. I’m presenting a very simple plan that can
speed you towards financial independence. Get good at it before you
become entangled in any of the trickier ideas.
Let me give you one example that has been promoted in seminars for
the last couple of decades. In this scheme you use discounted bonds as
security when you borrow the owner’s equity.
Do you know anything about discounted bonds? Then right there this
is not a very practical idea, is it? Here’s how it works.
You are negotiating to by a $90,000 home. The existing mortgage is
$30,000, so the seller has $60,000 of equity in the home. The seller needs a
$9,000 down payment, so you have to find a way to come up with $51,000
to cover the seller’s equity.
You go to a stockbroker and explain that you need a discounted bond
or bonds that will pay $51,000 at maturity. The broker finds bonds with a
face value $51,000 that you can buy for $29,000.
6-9
You tell the seller you will pay him the $9,000 down if he will carry
back his $51,000 equity. This loan will be secured not by a second
mortgage on the property, but by the bonds that will pay the seller $51,000
in ten years.
$90,000 Sale price
9,000 Down payment
30,000 First mortgage
51,000 Owner’s equity
The seller agrees to carry back the $51,000 secured by the bonds.
This means that there will be no second mortgage necessary to do this deal.
So you can go to a lender and borrow $70,000 with a new first mortgage on
the property. You use $30,000 of that $70,000 to pay off the existing first
mortgage, $29,000 for the purchase of the bonds and $9,000 for the down
payment. That leaves $12,000 that is all yours.
Now there are plenty of other considerations here including taxes, but
how often do you think you could find someone who would go for that deal.
I admit I have never tried it. I have enough of a struggle just to get sellers to
understand a little basic creative financing. I have a feeling that the first
time I mentioned bonds they would show me the door.
Please don’t misunderstand me. I think we should all learn everything
we can about making money. I never stop learning. Every once in a while I
find some little technique that I feel very comfortable with and I begin using
it whenever I can. I think that is the key. Use what works for you and what
you understand.
Get good at what you are learning in these pages and you really won’t
need much else.
Subject To
Let’s cover a slightly advanced technique that you may consider if
you’re getting started with little or no cash. It is called buying “subject to
the existing mortgage”.
Here’s an example of a recent deal we put together. There is an Air
Force Base in our area. Service people are frequently transferred –
sometimes on short notice. This is a prime area for finding motivated
sellers.
An Air Force officer responded to some of our marketing. He had
been transferred. He and his family were living in a home they had
purchased 20 months earlier. He had bought with a small down payment
VA loan, so he had equity of about nine to eleven thousand dollars. He had
talked to a few real estate agents and they explained that after commission
and closing costs he would have to come out of pocket to cover the cost of
selling.
Here’s how we bought his home. We offered to pay him $1,000 to
help with his families moving costs (the military handles most of it). We
explained that we would buy the house “subject to” the existing loan. That
means the loan would remain on the house and it would stay in his name.
We carefully explained that after he signed the deed we would own
the home and make the loan payments, but that the loan would still be in his
name and if, for some reason, we were not able to make the payments the
lender would look to him for the payments.
We were buying the home for about 10% below fair market value. If
we rented the home the monthly rent would just cover the monthly loan
payment. But we did not rent it. We sold the home on a lease with option to
purchase.
Even though it is very easy for people to qualify for home loans in the
easy money conditions that exist as this is written…some people have such
bad credit scores they can’t qualify for a real estate loan. Those are the
people we target as buyers.
We advertise our “subject to” homes as Rent to Own. We screen
those who respond to find the ones whose financial problems stem from
something that was mostly beyond their control. It could be they were not
able to work for a time because of an accident, or they lost a job and
couldn’t keep up with bills, divorce …or something other than just financial
irresponsibility.
We insist that our potential buyers talk with our mortgage broker and
explain their current financial situation. With this information the broker
determines if they can do certain things to get their credit score back to a
number that will qualify to buy the home in question. In other words, he
explains exactly what they must do during the option period to be able to get
a loan to buy our home before the option expires.
If the broker says these buyers won’t be able to buy the home in 12 to
18 months we look for another potential buyer.
We explained to the Air Force home seller exactly what we planned to
do and that our lease/option buyer will get a new loan when they buy and
pay off the loan that has the officer’s name on it. He agrees to this because
he is motivated and the deal is in his best interest.
We sell the home to our lease/option buyers for a markup of 15%
above the current fair market value. That is the premium we earn for
creating a situation where they can own a home. Their monthly payments
during the lease period will be one to two hundred dollars above the
mortgage payment.
Why is this a good deal for us? Remember we bought a $170,000
house for $1000 cash that has about $10,000 in equity. We are selling the
house for 15% above market value or $195,500.
When our buyer’s exercise their option and buy for $195,500 we will
pay off the $153,000 mortgage and pocket about $40,000 after costs. That
does not include the few hundred dollars of positive cash flow we collect
from the monthly lease payments.
Was this a no money down deal? Even better. Yes, we gave the Air
Force family $1,000, but we collected a $5,000 down payment from our
lease/option buyers.
What about the “due on sale” clause in every current mortgage
document? We ignore it. There is nothing illegal about buying a home
without paying off the mortgage. The lender has the contractual prerogative
of demanding the loan be paid off if the property is sold…. BUT they aren’t
required to do so.
In practice, most of the time lenders are not interested in calling a loan
due as long as the payments continue to be made on time. Will this always
be the case? If interest rates climb then it would be in a lender’s best interest
to have the loan pay off, so they could lend the money again at a higher
interest rate. At that time they may keep a closer watch on what is going on
with property that secures their loans.
That would mean that they would have to closely monitor the
recording activity of every property in every county in the U.S. An
expensive proposition and one they will not enter into lightly.
Many of the old “no money down” techniques that were effective
when loans were easily assumed can now be put into practice using “subject
to”.
What if interests rates start to climb? The interest in “subject to”
buying will quickly fade. We limit our lease options to a maximum of 2years.
What if the lender learns you have purchased a property subject to and
calls the loan due. To force you to pay off the mortgage they would have to
start a foreclosure action. That takes months and gives you time to sell or
find new financing. You first action would be to talk to the lender and see if
they would leave the loan in place if you agreed to a higher rate of interest.
There would be room for negotiation with the lender and very possibly you
could strike a deal that would be acceptable to both of you.
To find nice homes with little equity we like to market in housing
developments that are just a year or two old. Many people have over
extended themselves in buying their new home and even the slightest
financial set back can motivate them to sell their homes. That allows us to
buy very nice homes with no maintenance problems subject to an existing
mortgage and sell for a profit on a lease/option.
More on lease/options next.
SEVEN
Options and Leases
Options and leases are very powerful tools for the single-family home
investor. They have benefits for both the homebuyer and seller. They are
especially useful now that you will seldom find a home that has an
assumable loan. With a lease/option you can do deals that otherwise might
be beyond your reach.
An option is a contract between a home seller and a homebuyer. It
gives the homebuyer the legal right to buy the home at an agreed upon price
during a specified period of time. An option must be in writing to be
enforceable. There must be consideration in the option agreement. That
means that the buyer must give something to the seller in return for the
option. The consideration is most often money, but it could be anything of
value including your own labor or your agreement to lease the property in
question.
The seller is called the optionor and the buyer is the optionee. The
optionor is bound by the option agreement to sell the property to the
optionee at the agreed upon price and terms at anytime during the option
period. That means the seller must sell, but the buyer has the option of
buying or not buying. The owner can sell to no one else during the option
period.
Why would a seller agree to an option? Because you are making the
offer to a motivated seller. They have a burning need to sell the property
quickly. Secondly you are going to offer to lease the property during the
option period. The lease/option gives you complete control of the property
for the duration of the lease/option period.
The option agreement will include the exact terms of the sale when
and if you decided to buy the property. In many cases that agreement will
be very close to the seller’s asking price. You can do that because the
lease/option will be for a term of years. During that time the value of the
home will rise and there will be some pay down of the mortgage balance, so
when you decide to buy the previously agreed upon price should be a
bargain. If the home has not increased in value you may choose not to
exercise your option.
What will you offer the seller as option consideration? Usually some
cash will help the deal go together, but you could offer anything of value.
That could be a promissory note, a used car, agree to pay off a credit card
debt or just the fact that you agree to lease the property.
The seller does not have to pay income tax on any cash received as
option consideration until you both exercise the option and buy the property
or the option expires with no sale. That is an advantage that you will explain
to the seller if you are offering cash consideration. They have the use of the
money tax-free for the time the option is in effect.
During the option period the seller still is the legal owner of the
property, so she gets any tax benefits the property offers.
You as the buyer get control of a nice property for a small down
payment (or other consideration), the right to buy it later at a reasonable
price and a lease that gives you physical control of the property with the
right to sublease the home.
Here’s how a deal might shape up. You find a nice home being
offered for sale at $115,000. The seller has a job in another state and must
move his family there in a matter of days. He can’t afford to make both the
payments on this house and the rent on the new home he will be moving
into. He wants to sell now!
7-2
There is a large mortgage on the property and you are not able to put
together a profitable offer that would allow you to get a new loan on the
property. Or perhaps you could not qualify for a loan at this time. So you
make a lease/option offer.
You offer $3,000 as option consideration and agree to lease the home
with the right to sublease. The option period and the lease are both three
years in length. The lease payment will be about the same as the owner’s
monthly mortgage payment. You explain that you are ready to do the deal
right away and sellers can be on their way on the date they specify.
This offer lifts the burden of the home from the sellers and also covers
their monthly financial responsibility. They are free to get on with their new
lives.
Of course you have plenty of flexibility in structuring the deal. If they
wanted more cash consideration you could offer to pay them the first two
months rent in advance, in addition to the $3,000. You would recover that
extra money when you rented the house. If you rented the home quickly
you would collect from the renter the first months rent and an equal amount
as a security deposit. That would cover the additional payment to the seller.
You could pay less than their mortgage payment in monthly lease
payments. For example: If they are strongly motivated they may be willing
to accept a monthly lease payment that is one to four hundred dollars less
than their mortgage payment. They realize that it will be better to collect
part of their mortgage payment rather that having to come up with cash for
the entire payment.
On the other hand you may have to pay one or two hundred dollars
more than the mortgage payment to do the deal. That may be OK if you are
sure you can rent the property for at least that much. You can ask that a
portion of the monthly lease payment ($250?) be credited towards the
purchase price of the home when you exercise the option.
In the lease you agree to take care of all maintenance costs on the
property up to $100 per month or so.
You can ask that this amount be credited toward the purchase price
when you exercise the option. Ask for as much as the seller will allow to be
credited toward the purchase price. Nothing comes out of the seller’s pocket
for these credits and if the seller is asking for a bit more than market value
for the home this is a way to compensate for the higher price when you buy.
So here is the basic deal:
1. The seller agrees to a lease/option deal.
2. Purchase price and all terms of the sale are agreed upon.
3. Option consideration is agreed upon.
4. Terms of the lease are agreed upon.
How many years at
how much per month, plus amount you will pay for
maintenance.
5. The amount of each monthly payment that will be credited
towards the purchase price. This costs the seller nothing at
the time and is only credited to you if you buy the property.
6. The seller will pay all taxes, insurance and loan payments
when due.
Here are additional requirements:
•
The sellers must be the legal owners of the property. They
must reveal any and all encumbrances such as mortgages
and liens.
•
The sellers must agree that they will not further encumber
the property or transfer any interest in the property while the
option is in effect.
•
The sellers agree to deliver good title when you exercise the
option. If the good title cannot be delivered the buyer will
be entitled to a refund of all money paid to the seller,
including rent, as damages.
•
The seller must agree that you can record a memorandum of
the option which will include the following:
1. The seller’s name.
2. The buyer’s name and address.
3. Legal description of the property.
4. The term of the option.
5. An agreement not to sell any interest and not to
encumber the property during the term of the option.
All of this is can be found in the option form included in this section
of the manual. This document and accompanying materials are designed to provide authoritative information in regard to the subject matter covered in it. It is for illustration purposes only and presented with the understanding that the author and publisher are not engaged in rendering legal, accounting or other professional opinions. If legal advice or other expert assistance is required, the services of a competent professional should be sought. |
