It wasn’t too long ago that real estate markets nationwide were down, and I mean very down. Many of you remember well the years 2007-2009, which proved to be a historical event for American housing. That economic crisis, in great part caused by the proliferation of subprime mortgages, led to significant bankruptcies in the financial sector and a recession which shrunk GDP by 0.3% in 2008 and 3.1% in 2009. The effects on real estate prices were swift and significant, as for the first time ever our country experienced a nationwide fall in housing prices As a result houses were on the market for longer and real estate prices plummeted. Additionally, foreclosures were up and mortgages were even harder to come by. Under these nightmare real estate circumstances, both buyers and sellers were trying to find solutions that they could both live with.
We fast forward ten years later to the present. From where I am standing, we have woken up from that “nightmare” era of real estate and can wipe the beads of sweat from our brows with a sigh of relief. As an optimistic person, I feel more confident in real estate investing now than I did then, that’s for sure. But as a BSA Scoutmaster of Troop 201, my gut tells me to always “be prepared”. That colossal fall in the real estate market can always happen again and as the saying goes “Fool me once, shame on you, fool me twice, shame on me.” For that reason, I prepare myself and my real estate investor clients to be ready to implement a few proven and secure real estate strategies and I am ready to share them here with you.
Though “Owner Financing” is not a new concept, it is beginning to play a larger role in the real estate market. But what exactly is owner financing? In Texas we have 3 basic ways to “owner finance” a property. Which is best often depends on your situation? Several factors to look at include: how long with the payment term be, is there a lien on the property, the motivation for owner financing. Here are the three principal methods:
Promissory Note & Deed of Trust
This is the same thing the bank will do. However the Seller takes the role of the bank. The Buyer/Borrower will sign a promissory note payable to the Seller/Lender. This note will detail the payment amount, interest rate, principal amount and any other specifics to the note. In Texas we use a Deed of Trust to secure this promissory note. The deed of trust gives the Seller/Lender certain rights if the note is not paid, including the right to sell the property at a foreclosure sale.
In my opinion, this is the best way to handle the transaction without other “issues”. It allows the Seller to divest himself or herself of title to the property (and responsibility for anything that happens after closing on the property) allowing him/her to qualify for a new residential loan. For the Buyer this allows him/her to have title to the property and do as he/she sees fit on the property, knowing that improvements will his/hers to keep. The key thing they need to do is keep up with the payments. Everyone is happy.
Unfortunately this option is not always available. If the Seller has a mortgage on the property, the Seller must first get authorization (in writing) to enter into this transaction, to avoid the “due on sale” clause (if you sell or transfer the property the note is due in full). Most lenders are reluctant to approve this type of transaction because they do not have the financial information on the Buyer nor do they have a contractual relationship with the Buyer.
Usually the reason for this type of transaction in the first place is the Buyer has some credit issues. So we move on to other options.
Lease with Option to Buy
Another option that I recommend is the Lease with Option to Buy. The way this works is that the Buyer will lease the property for a period of time, during which Buyer can exercise an option to buy the property at a set price. There can be some part of the rent payment applicable reducing the sales price. Usually the taxes and insurance are also payable by the Buyer/Tenant as part of the transaction. Once the Buyer is ready, he/she notifies the Seller that they want to buy. A contract of put together based on the terms of the lease and the closing happens just like a regular sale (see above). If the option is not exercised, the payments will be considered rent and at the end of the term the lease can be renegotiated or the Tenant can move out.
This transaction does not trigger the due on sale clause, but title remains in the Seller, and Buyer is still a Tenant. As you can see this situation provides less certainty to each party. The Seller is not assured of selling the property during the lease term, only that there is a strong possibility. The rental payments covering the note make this easier to accept. On the Buyer’s side if they cannot get financing during the lease term, they could end up losing what they thought was equity. Additionally any improvements they make would typically remain with the property so they would also lose that investment.
Though this is not the optimal choice, under certain circumstances, this may be the most viable option.
Contract for Deed.
Contract for deed transactions used to be much more common. In this type of transaction, the Seller enters into a contract with the Buyer outlining the payment terms for the purchase of the property. The Buyer makes payments for a set time, at the end of which the Seller is obligated to turn over the deed, free of encumbrances a liens. If the Buyer defaults, the Seller keeps the property (and before recent changes in the law the money paid as well). This was a great deal for the Seller, and a Buyer in need would take the deal.
As you can see, this situation left a lot of room for abuse, which resulted in changes to the law which required the filing of the contract with the property records (triggering the due on sale clause). Additionally, the termination of this arrangement now requires additional notices and refunds of payment based on the percentage paid. I do not recommend this transaction because it is fraught with traps for the unwary and it has not been tested sufficiently in the courts.
There are many options for both buyers and sellers to get a deal done, even with the current market conditions. I hope this provides you a simplified view of some options that are available to you. The above information is Texas specific. Your situation is fact dependent and you should seek competent legal advice before entering into one of these transaction.