Creative Mortgage Financing Techniques
Lease Purchase Agreement - What is it and How Does It Work?
A Lease Purchase Agreement is a contract between the owner of a property and a potential purchaser of that same property, wherein the purchaser is permitted to live in the property as a renter for a period of time before actually buying it. This concept presents a potentially significant opportunity for both the buyer and the seller, yet also presents some serious potential problems for all parties involved.
The Lease Purchase Agreement is Specific and Complex
The Lease Purchase Agreement is a complex contract that needs to contain very specific language relating to several different situations and points of necessary discussion. It is much more complicated than a standard real estate purchase contract; in fact, the Lease Purchase could be described as a combination of the standard rental lease contract and the standard real estate purchase contract, with several additional sections and items. Due to the complexity of these agreements, there is a danger to both the buyer and the seller that things will not work out as anticipated if the contract is not structured appropriately from the beginning.
Benefits to Both Seller and Buyer
The potential buyer of the property benefits from this type of contract because it gives him the opportunity to actually live in the house and the neighborhood before committing to purchase the home. Additionally, it gives him sufficient time to arrange for financing, repair his credit, save for a down payment, etc. The seller is also granted the same opportunity and time frame to search for another suitable home, arrange his own finances, etc.
Three Basic Segments: Rental Contract
There are three basic segments of a Lease Purchase Agreement: the Rental contract, the Property Purchase contract, and the Option contract. The Rental contract is nothing more than you would expect out of any standard landlord-tenant agreement, wherein it is agreed that the owner of the property is responsible for all maintenance and upkeep, while the tenant is responsible for payment of the rent every month, etc. The terms of this portion of the overall Lease Purchase contract must be negotiated and confirmed right along side of everything else.
Property Purchase Contract
The Property Purchase portion of the Lease Purchase Agreement contains everything that you would expect out of an ordinary real estate contract. Here, the buyer and seller agree on everything from price, to the physical condition of the property, and any other stipulations they deem necessary and appropriate.
Option Portion of The Contract
Lastly there is the Option portion of the contract, which is the most significant and important piece of the entire agreement. It is in this section that the real details of the relationship and the sale of the property will be stipulated and maintained. Although the buyer and the seller may include any items or scenarios that they feel necessary, there are some common threads that nearly every Lease Purchase Agreement has, and they are as follows:
¬ A certain portion of the tenant’s rental payments will go toward reducing the final sale price of the property.
¬ There is a maximum period of time that the buyer may remain as a tenant/renter before he must exercise his option to purchase the property (the expiry of the lease).
¬ If the renter chooses not to purchase the property at the end of his lease, he shall forfeit an agreed-upon percentage of those rental payments that were previously credited toward his purchase price.
¬ If the seller chooses not to sell the property at the expiry of the lease, the tenant will be refunded an agreed-upon portion of those rental payments that were previously credited toward his purchase price.
¬ The sale price of the home will both be determined at the outset of the lease and remain unchanged regardless of any potential changes in the fair market value of the property, or the sale price of the property will be determined by an independent appraisal at the exercising of the purchase option.
¬ The seller will inform the buyer whether or not independent financing arrangements are necessary, or if the seller is willing to hold a note on the property himself and simply convert the rental payments into mortgage payments.
Different Situations to Suit Both Seller and Buyer
Being that every situation is different and unique, there are countless other potential additions or subtractions that may be written into any Lease Purchase Agreement. The important fact is that this type of arrangement could possibly suit both the buyer and the seller very well. There is no clear-cut template for these types of contracts, therefore there exists some danger that one party could end up in a better position than the other. For this reason, it is essential that all parties involved conduct their due diligence to ensure that the contract is fair and valid.
What is Rehab Financing?
Rehab Financing is the term that describes a unique type of loan arrangement that a real estate investor may obtain for the purposes of buying a home with the specific intention of re-selling it again after having completed repairs or upgrades. There are an increasing number of lenders, most of them outside the normal mortgage channels, who are willing to loan real estate investors the money needed to pay for repairs and/or upgrades to properties.
Specialized Finance Companies
The majority of these specialized finance companies use independent appraisers and experienced real estate professionals to assist in assessing whether or not the proposed real estate venture has merit and a good likelihood of generating a profit. These individuals are typically former property appraisers and/or contractors with a background in home repair or other real estate focused experience. Provided that the lender’s analysis proves a definite potential profit can be made from the suggested borrower’s plan, they are very likely to offer a quick approval for the loan.
Requirements and Considerations a Lender Will Evaluate Before Giving Approval.
Of course, simply having a good plan and a positive assessment does not guarantee that borrowers will get approved for their Rehab Loan. There exists a myriad of other requirements and considerations that the lender must evaluate before giving approval for financing, and the chance of successfully rehabbing the property is only one of them. The lender will always consider such things as the real estate investor’s prior experience, credit history, employment history, and current financial resources. With loan applications of this type, it is also not uncommon for these lenders to interview the applicant to discuss actual ideas and comprehensive planning methodology.
Less Stringent Credit Requirements
Since these loans are typically very short-term, the lender will usually have less stringent requirements as far as credit score, credit history, employment length, and financial resources. This is because the loan is designed to offer the borrower the opportunity to quickly purchase, repair, and/or upgrade a residential property with the specific intention of reselling it within a short period of time. Therefore, the lender is not typically concerned with the borrower’s long-term ability to repay a loan over several years or even decades.
Previous Real Estate Experience and Business Resources are Important
These lenders are usually most concerned with the borrower’s previous real estate experience, personal and business resources available to assist with the project, and their own independent analysis of the project’s merit. Assuming that each of these things falls within their pre-determined criteria for approval, a borrower may find his application for funding approved rather quickly, allowing him the opportunity to immediately begin his project.
Uses for Rehab Loan Funds
Most real estate investors will use the funds from a Rehab Loan for multiple things, the most common being to pay the mortgage for the interim period while the work is being done, and also to pay for the contracting services that are required to complete the desired upgrades and/or repairs to the home. Less common, but still plausible, is the idea of using some of the proceeds of the Rehab Loan as a down payment on the property in the event that the borrower does not have sufficient independent funds available to successfully qualify for a mortgage without a down payment.
Rehab Loan is Not a Mortgage
It is extremely important to clarify that this type of loan is not a mortgage. In fact, the real estate investor typically secures alternative financing through other channels prior to applying for a Rehab Loan. Since the Rehab Loan is usually only for the amount necessary to complete the repairs/upgrades to a home, the investor still has to come up with enough money to actually purchase the property. However, it is also important to note that a large majority of investors obtain 100% financing when buying investment properties, therefore the actual cash outlay for them is minimal. Additionally, the proceeds from the sale of the house after repairs should be enough to cover the required mortgage payments, rehab loan payments, contractor fees, and any other miscellaneous expenses incurred during the working stages.
A Project Should be Fully Researched and Evaluated
With so many costs and expenses to analyze and prepare for, this type of procedure has the potential to become extremely confusing and potentially disastrous to the inexperienced real estate investor or property flipper. For this reason, it is highly recommended that a project like this be fully researched and evaluated before any actual contracts are signed or negotiations are concluded.
What Are Tax Lien Certificates?
The popularity of using Tax Lien Certificates as a method of obtaining residential real estate has increased exponentially over the past decade. Using this technique allows real estate investors the chance to acquire homes without shelling out substantial sums of money or going through the grueling process of obtaining mortgage loans. There are obviously some risks associated with this type of investing and property acquisition, but these risks are usually considered negligible by investors who are familiar with the tax lien market.
How a Tax Lien Certificate Works
So how can you acquire property by using tax lien certificates? Well, in nearly every state in our country, if a home owner does not pay the taxes due on his property then the city or county will issue a lien on that property. Most states also allow for that lien to become what’s referred to as a “primary” lien, meaning that it takes precedence over any other claims against the property, and therefore must be addressed before anything else.
Tax Liens are Auctioned or Sold to Investors
These liens are usually sold to investors in an auction style format as a way for the state or municipality to generate further revenue. Investors who are familiar with this process will attend the auction and bid on the tax liens they want. Once a bidder has successfully taken possession of a tax lien, he then becomes the person with the primary claim against a property, regardless of the amount of the taxes that are due. The sum total of the taxes has no bearing on it’s placement in the priority list of creditors and claimants, and is always placed first by the state.
Investors Make Money off the Interest and Penalties
Very simply, this means that the home owner will be unable to sell the property or obtain additional financing without first satisfying the tax lien. Any time that a tax lien is issued against a particular property, there is a mandatory interest penalty that is attached to the lien that becomes a permanent addition to the total balance due. If and when a home owner decided to satisfy his outstanding property taxes and have the lien removed from his property, the holder of the lien would be entitled to keep the mandatory penalties and interest fees that have accrued since the issuance of the lien. The original amount of the taxes due would be forwarded to the appropriate jurisdiction by the investor. This scenario guarantees that an investor will receive profit on his purchase of the tax lien, and the amount of that profit will be different in every jurisdiction.
Potential to Take Possession and Title to a Property
The most attractive part of investing in tax lien certificates is the potential to take possession and title to a property. The legislation in the majority of states stipulates that if a home owner neglects his taxes for a certain number of years, then the holder of the tax liens has the right to foreclose on the property immediately following the acceptable grace period. The most common grace period for a home owner to satisfy his back taxes is three years. If he does not pay the taxes due after three years, then the investor may begin foreclosure proceedings and take title to the property.
The best part about this situation is that the tax lien holder then owns the property free and clear, and is in no way obligated to deal with or repay the mortgage company. This is how an investor may acquire a property for a miniscule amount of money and owe nothing on it. Or, in the least, be assured of a sizable return on his investment when the interest and penalties are added to the lien.
Mortgage Lenders Often Pay Outstanding Tax Balances
Now, because this scenario presents a significant risk to the mortgage company, it is not uncommon for lenders to actually pay the outstanding balance due on the property taxes and simply add that sum into the outstanding mortgage loan. The lender stands to lose quite a bit if the home owner loses possession and title to the property. In that situation, the borrower is still responsible for the outstanding loan balance, yet there would no longer be any collateral with which the loan was secured. For this reason, it is very uncommon for mortgage companies to pay the tax lien on the home owner’s behalf. However, there are always lenders who are not up to speed on such situations, and that is why the tax lien market is so popular with would-be real estate investors.
What is an Assumable Mortgage?
Assumable Mortgages are something that have been mostly ignored and pushed aside in recent years simply because of the current state of interest rates. With rates at an all-time low over the past several years, the necessity and attractiveness of Assumable Mortgages has decreased significantly. However, with increases in rates looming in the foreseeable future, there is a good likelihood that such mortgage programs will once again come to the forefront of both investor and broker radars.
Buyer of a Property Takes Over Mortgage Payments From Seller
The general concept of the Assumable Mortgage is relatively simple, yet the actual details of such a contract can be extremely complicated and difficult to successfully implement. In brief, an Assumable Mortgage is one in which the buyer of a property simply takes over the mortgage payments from the seller, thereby avoiding the necessity of a new loan. Of course, that is over-simplifying the idea, as there are a great many details that need to be considered and agreements made before such a transition could ever be concluded.
Contract Must Contain Language Allowing the Mortgage to Be Assumed
To begin, the seller’s mortgage contract must already contain language stating that it is indeed able to be assumed by a future buyer of the property. Without this language, there would be no point in even investigating the effectiveness of such a deal. Keep in mind that the lender must now evaluate the new borrower’s ability to repay the outstanding balance of the existing loan, and therefore they will review the borrower’s situation just as they would with any new applicant. This means that the buyer will be subject to the same application paperwork, credit check, employment verification, and income verification procedures as any other brand new loan applicant.
Most Mortgage Contracts Have Stipulations Governing These Situations
Plus, most mortgage companies today have multiple clauses inserted into loan contracts that reference just this situation. Many of them are prohibiting the assumption of mortgage payments by anyone other than the original borrower, or are stipulating that if they were to permit an assumption then they would also reserve the right to increase interest rates to those currently considered acceptable and appropriate. If the lender were to raise the interest rate on the existing mortgage in the event it was assumed by another lender, then this essentially defeats the purpose of the deal.
Factors to be Considered Before Assuming a Mortgage
However, if the home buyer meets all of the lenders pre-defined criteria to become eligible to assume the seller’s mortgage, there are still several other factors that need to be considered before such a deal can be concluded. The actual sale price of the house is usually the largest consideration at this point. Depending on how long the seller has owned the property, and how much the value of the property have appreciated, the balance of the mortgage may actually be significantly less than the fair market value of the home. In that situation, the buyer has only two choices – pay cash to the buyer for the difference between the outstanding mortgage and the sale price, or obtain additional financing for the balance.
Advantages of an Assumable Mortgage
Assumable Mortgage deals are very attractive to those property buyers with large enough sums to cover the increased value over the remaining mortgage debt. With this method, buyers are able to purchase property with immediate equity and take advantage of loan provisions that are potentially much more attractive than those of the currently available programs. However, such deals are not only reserved for those buyers with large sums of disposable cash reserves. For the buyer who requires additional financing to make up the difference in the value of the home, there could still be significant positive potential in assuming an existing contract, and this is evaluated by comparing the total interest rates and monthly payment totals of the two combined loans, to that of one primary mortgage for the entire sale price of the home.
Thoroughly Understand and Analyze the Costs and Requirements
Before a buyer and seller agree that assuming an existing mortgage loan contract is worth investigating, they should first find out if it is actually possible, and if so what conditions would need to be met for the lender to approve such a transition. Only after thorough analysis and complete understanding of all the costs, fees, and additional requirements should the buyer and seller begin implementing the assumption process.
What Does It Mean When a Seller Holds a Note?
This is a rarity in today’s day and age, yet there are still a number of instances where a seller is willing and able to “hold a note” on a property. Very simply, this means that the buyer does not need to obtain a loan from a mortgage company in order to purchase a home. Instead, the seller of the home will negotiate payment arrangements with the buyer, and all monthly payments will be made to the seller until such time as the agreed-upon sum has been paid.
Risks to the Seller
Holding a note presents significant risk to the seller of the property more than the other parties involved. In the event that the buyer does not pay, the legal process to elicit payment or foreclose on the property is a long and expensive one. But, it is entirely possible and in some cases holding a note may make perfect sense.
Lump Sum vs. Regular and Predictable Stream of Income
For the seller who does not need a lump sum upon closing, the idea of a regular and predictable stream of income over several years could be very appealing. The majority of sellers who hold notes are in situations where the property purchased is not their primary residence, and a lump sum is not required to secure alternative living arrangements.
Sellers Need to Thoroughly Investigage Buyer’s Credit Worthiness
Sellers who hold notes are solely responsible for investigating the buyer’s credit worthiness and ability to pay the agreed-upon monthly amount for the duration of the contract. This can present a difficult challenge because the average individual does not have the resources to conduct such a search, nor the experience to appropriately evaluate the results of such an investigation. Without prior experience for comparison, a seller may find himself in a precarious place if he makes a poor choice.
These are the reasons that sellers who hold notes are not seen as much anymore. The potential for complications and the cost involved with correcting any problems that may arise are not worth it to the seller. It would, in fact, be easier and smarter for a seller to just use traditional means to sell his house and require that a buyer obtain his own financing.
What Are Pre-Foreclosure Techniques?
With the number of people finding themselves in financial crisis increasing at a frighteningly exponential rate, the number of home owners facing foreclosure on their properties is increasing just as quickly. In recent years, there has been a massive shift in real estate investor interest and ingenuity in terms of developing new ways to capitalize off of this growing, but unfortunate, trend in the marketplace.
How Pre-Foreclosure Techniques Work
Although various modifications to the Pre-Foreclosure techniques have been developed over the years, the basic premise still stands true. A real estate investor will approach a home owner who is having financial difficulties and is in the early stages of foreclosure. That investor will work out a deal to save the home owner from losing his house, and at the same time actually acquire possession of the property. There are various methods of accomplishing this goal, yet each one is simply a minor modification of a few general techniques.
Potentially Problematic
Due to the significant negative publicity and potentially problematic issues surrounding this manner of acquiring real estate, we will not continue to go into detail regarding the specifics of how this is successfully accomplished. There are a number of stances people take when discussing this particular real estate investment strategy, and there always ends up being an issue about morals, ethics and many other arguments on the subject.
