SELLER (OWNER) FINANCING

Probably the most common creative financing strategy is seller financing. Seller financing is when the seller of the property acts as the bank and finances all or a portion of the purchase price on behalf of the buyer. 

This arrangement can be beneficial to both the buyer and seller. This arrangement allows the seller to sell their property while maintaining a higher sale price. The buyer then is able to purchase the property with no or little money down.

Seller financing can be broken down into further subcategories such as:

LAND CONTRACTS

A land contract, also known as a contract for deed, is a written legal contract, or agreement, that allows the buyer to make payments directly to the seller until the full purchase price has been paid. The seller retains the deed until the contract is fully repaid by the buyer. Land contracts can be structured a number of different ways with varying down payments, term lengths, interest rates, etc. 

Oftentimes the seller in a land contract requires a balloon payment from the buyer. Since most sellers don’t provide financing at term lengths similar to conventional lenders, the seller can require a balloon payment. A balloon is a large lump sum payment that covers the remaining balance of the loan.

WRAP AROUND LAND CONTRACTS

A wrap around mortgage is when the buyer takes over the mortgage payments on the seller’s existing mortgage. The buyer makes a single monthly payment to the seller, who then forwards the payment for the existing mortgage to the original lender. This allows the seller to receive a higher interest rate from the buyer than what the seller is currently paying on the existing loan.

LEASE OPTIONS

A lease option allows the buyer to lease the property with an option to purchase the property either during or at the end of the lease term. A portion of the monthly rent is credited towards the purchase price. Once the lease period is up, the renter can exercise the option to complete the purchase for the remaining balance.

For example, suppose a homeowner has a tenant who is looking to purchase a home in the future. The landlord or owner may offer the tenant a lease option on the property. The tenant will pay a premium on their monthly rent which would go towards a down payment if they chose to exercise their option to purchase the property. At the termination of the lease, the tenant has the option to buy the house they currently live in at the current market prices.

OTHER CREATIVE FINANCING OPTIONS

ASSUMPTIONS

Assumptions are when one party takes over the obligations of another. In real estate, this usually means that the buyer steps in and takes over the seller’s existing mortgage payments. This creative financing strategy can be beneficial to the buyer when current interest rates are higher than what they were when the seller purchased their home. By assuming the seller’s mortgage, the buyer is able to lock in a below market interest rate. 

Banks or other traditional lenders usually require the buyer or party assuming the mortgage to have: 

• A qualifying credit score
• Debt-to-income ratio below a certain threshold 
• Lower principal balance than the home’s market value (i.e. not be upside down)

Mortgage assumptions allow both buyers and sellers to benefit from lower interest rates on the remaining mortgage balance.

SUBJECT TO SALES

A subject-to-sale is similar to a mortgage assumption; however, the buyer that is taking over the existing mortgage is not formally assuming the loan. The difference between a subject-to-sale and mortgage assumption is that the original homeowner remains responsible for making the mortgage payments, meaning their name stays on the loan. 

This type of creative financing deal allows the buyer to purchase property without taking on any debt or have any qualifying credit requirements. However, the buyer is assuming all the risk if the original homeowner defaults on their loan. If the homeowner defaults or goes bankrupt, the buyer could be left with nothing.

HARD MONEY

Hard money is when borrowers get funds from private investors or companies. Hard money loans typically have a lot higher interest rates and fees compared to conventional mortgages, but allow borrowers who don’t qualify for traditional loans to still finance their real estate investments. These loans are usually based on the property’s value rather than the borrower’s credit, and are often used for rehab projects, flips, or as bridge financing. Hard money provides fast approvals and funding for real estate deals that banks shy away from, but the higher costs mean it’s best for short-term projects or until the buyer can secure more traditional funding.

BENEFITS OF CREATIVE REAL ESTATE FINANCING

Utilizing creative financing for real estate has many advantages, both for buyers and sellers:

LOW DOWN PAYMENTS

Creative financing can help buyers purchase investment properties with little to no money down. Techniques like seller financing, mortgage assumptions, lease options, etc open the door (pun intended) for buyers who lack the money for a traditional financing that would require upwards of a 20% down payment.

INCREASED LEVERAGE

Leverage is an important component of real estate investing. With traditional financing, leverage is limited to what the lender will offer which is usually around 80% loan-to-value ratio (LTV). Creative financing allows buyers to leverage 90-100% financing, reducing their cash contributions and choking off their cash flow. More leverage means the property’s cash flow and appreciation can work harder for you. Even a few percentage points increase in leverage can mean tens of thousands in added equity.

FLEXIBLE QUALIFYING

Creative financing options often involve fewer and less strict qualification requirements than conventional loans. Methods like seller financing, subject-to-sale, lease options, etc. don’t require credit checks or debt-to-income ratio analysis. 

COST SAVINGS

Creative financing techniques help buyers avoid mortgage insurance, origination fees, closing costs, and other miscellaneous fees associated with a conventional loan. Less money out of pocket means more cash flow and equity for the buyer.

For sellers, creative financing provides an alternative to real estate agent commissions by bringing in a buyer directly. Avoiding capital gains taxes through strategies like installment sales also puts more money in the seller’s pocket.

RISKS AND DRAWBACKS OF CREATIVE FINANCING

Creative financing can benefit both the buyer and seller; however, there are also some potential downsides to consider:

LESS PREDICTABILITY 

Creative financing deals tend to be less structured and predictable than conventional mortgages. For example, a seller in a land contract deal might not thoroughly track payments. Or they may demand a large balloon payment before the contract expires.

A higher degree of trust and communication is essential when financing outside the traditional lending system.

NOT EASY TO RESELL

It may be difficult for a buyer to find future exit options when reselling a creatively financed property. Techniques like subject-to sales can limit the pool of potential buyers and complicate transactions.

Finding a new buyer who also wants to utilize creative financing may narrow options. It helps to have a long investment timeframe when buying through creative means.

LEGAL COMPLEXITY 

Some creative financing strategies have less legal precedent and case law backing them up. Land contracts and lease options work differently across different states and municipalities. When using creative financing, it’s important to consult an experienced real estate attorney before entering into any non-traditional financing deal. 

Creative financing methods can help buyers and sellers complete more deals, the legal complexity requires careful navigation and professional guidance. Don’t go it alone. Call the ARG team today!