©2009 by Wendy Patton
It’s in the news day after day about how bad the real estate market is across the country. Available supplies are rising, builders are cutting back, foreclosures are skyrocketing, the sub-prime mess, prices are dropping, etc. This makes it a difficult time for real estate agents to survive. More and more listings just sit on the market and never sell. If you are a buyer’s agent finding qualified buyers is no easy task, they are few and far in between.
This is a time to get creative. Down markets are buyer’s markets, meaning your listings are competing for the smaller pool of buyers who have a large inventory of housing to choose from.
We hear about making sure your listing is priced competitively and it is well staged. These things certainly can help. However, often they aren’t enough. The reason is that you are still competing for the same small pool of buyers as everyone else. If you really want to get your listings sold, or as a buyer’s agent attract more buyers, you need to expand the pool of buyers. What I mean by that is that the existing pool of conventional buyers is comprised of people who want to buy now and can qualify for a mortgage now. We all know that the extreme tightening of the lending industry has made it much harder for prospective home buyers to qualify for mortgages. If you really want to sell your listings or get more buyers you need to expand your pool of buyers to include those people who want to buy a home but can’t qualify for a standard mortgage at this time. This pool is actually much, much larger than the pool of buyers who can get a mortgage right now.
Think about it. As a buyer’s agent how many times have you turned away a potential buyer because they couldn’t qualify for a mortgage? As a listing agent, how many of your listings have just languished on the market, never finding a buyer because of the competition?
Wouldn’t you have liked to get paid for a few of those?
Who are some of those buyers?
- Buyers who have moved from one area and are still trying to sell their old home and can’t qualify for two mortgages,
- someone who is going through a divorce and their existing home is tied up,
- a buyer whose credit is bruised,
- a buyer whose credit isn’t established enough yet to qualify for a mortgage,
Just to name a few!
In order to survive and even thrive in down markets you need to get creative. Don’t hold out for just the conventional buyers when there is so much more out there. In this article we will look at several choices you, as a Realtor®, can offer both your buyers and sellers:
- Seller Carryback
- Land Contract
- Lease Option/Lease Purchase
- Mortgage Assumption
Let’s take a look at some of the more creative methods you can use to reach a larger pool of buyers.
Seller Carryback – aka Seller Holdback or Seller Second Mortgage
Seller Carrybacks bridge the gap between conventional financing and more creative seller financing. In this case the home buyer can qualify for a mortgage but not for the full amount. They may be able to qualify from 70% to 90% of the purchase price. To cover the difference the seller must give the buyer a second mortgage covering the remainder, which is fully disclosed to the primary lender. The seller is essentially acting as a bank offering an additional mortgage. The terms of the second mortgage are entirely negotiable.
In the case of the seller carryback the sale of the property and transfer of the deed is completed. This allows the buyer to get their principal mortgage at the time the seller is providing the second mortgage. There are several advantages to this. By completing the sale the buyer is the new owner of the property, freeing the seller from the responsibility of taking care of that home. Additionally, if the seller has equity (beyond the amount of the second mortgage they are offering) they will get paid that equity. The disadvantages to this are:
- should the buyer default on their loan for some reason the seller would have to foreclose and
- The seller must actually have equity in their home so that when the buyer purchases their home the buyer’s first mortgage is enough to pay off the seller’s existing mortgage and hopefully cover real estate commissions.
As I mentioned the terms of the second mortgage are entirely negotiable. That means the interest rate, the frequency of payments, the rate at which the interest compounds (yearly, monthly, daily, etc.), whether the payments are principal and interest or interest only, whether there is a balloon payment, and the duration of the loan are all factors that can be set with the buyer. These terms should not be taken lightly either, as they can substantially affect your seller’s profit or your buyer’s costs by negotiating favorable terms. While all of these terms may sound a bit intimidating, fear not, you don’t have to resolve them on your own. As agents we mainly fill in the blanks when it comes to contracts. Talk with your brokerage’s legal representation to help you with the loan documents and terms. This gives you good CYA (Cover Your, you know what) which is crucial as a real estate agent. We don’t want to create liability. Plus using the attorney can help your client by setting favorable terms and protect them with proper documentation. If you are a listing agent I DO NOT recommend allowing the buyer’s loan officer to set up the second loan! Remember, they work for the buyer. They will be doing their best to make sure the terms favor the buyer and not your client.
To help you understand how important it is to get favorable terms for your client, let’s take a look at a variation in just a single term, the interest rate. All other terms being equal, let’s assume a seller carryback of $25,000, amortized over 30 years but with an 8 year balloon – this means the interest is based on a 30 year time table like a conventional mortgage, but the buyer will have to pay the balance after 8 years, usually by refinancing. If the interest rate is set at 8%, over the 8 year period the buyer would pay a total of $15,364.77 in interest on the loan. If the interest rate is set at 8.5% the buyer would pay $16,381.76 in interest. That’s just over $1,000 in additional interest for just a ½% increase in interest rate.
Real estate agents may not receive all of their commission upfront with a seller carryback. It will depend on how much equity the seller has left after carrying the second mortgage. If they do not have enough equity you would need to work out a payment plan.
There are a couple of important things to keep in mind when doing a seller carryback transaction. The first is that the primary mortgage lender must be fully aware that the seller is providing a secondary mortgage. Failing to disclose this constitutes fraud. Definitely not something we as agents want to be implicated in. The reason for this is banks lend based on what they feel the borrower can handle based on the value of the property. If they are willing to loan 80% of the value of the home and permit a second mortgage for 15%, requiring the borrower to put 5% down, that is the most the bank feels this borrower can afford. If they are only willing to loan 80% of the value with NO second mortgage, it’s because they feel the borrower cannot handle the additional mortgage. If the seller provides that mortgage anyway, you are violating the terms of the first mortgage.
The second thing you need to keep in mind with a seller carryback is another type of fraud. It’s the forgiven loan scheme. It works like this: The buyer is approved for, let’s say, a 90% mortgage. The buyer, their loan officer, or their real estate agent, might ask your seller to take a 10% second mortgage, but they adjust the purchase price up to cover all or part of that 10%. They disclose to the bank that the seller will provide a 10% second mortgage, but as soon as the sale is complete the seller forgives that 10% second. In other words, they accepted the 10% second but had no intention of ever making the buyer pay it. What this effectively does is make the buyer’s 90% first mortgage a 100% first mortgage instead. Make no mistake, even though the second mortgage is being disclosed it is still fraud. Fortunately this one is harder to pull off now because appraisers don’t have nearly as much fudge room as they used to.
Both of these types of fraud are very rare, and most likely you won’t encounter someone who asks you to do it. However, I want to make sure you are aware of them because no matter how badly you need that next commission, it’s not worth committing fraud.
Land Contract aka Contract for Deed
Land contracts are essentially 100% seller financing. In this case the buyer will not be getting any other mortgage except the financing the seller is providing. Land contracts can be structured 2 different ways:
- The seller can either close on the property with the buyer and convey the deed to them and the land contract exists as financing on the property or
- They can set the land contract in place and the deed isn’t conveyed until the buyer pays the land contract off, either by refinancing down the road or by paying the balance in full.
If you represent the seller it is to their advantage to do the second, where the seller retains the deed until the buyer pays off the land contract. If you represent the buyer the first option is better.
You may have heard that in order to sell on land contract the home must be owned free and clear. This is not 100% true. In some cases, the seller’s existing mortgage may have a “Due on Sale” clause. By conveying the home on a land contract with a mortgage the bank has the right to invoke the “Due on Sale” clause. However, it is VERY, VERY rare that a bank will invoke this clause as long as payments are being made. This is especially true in down markets where foreclosure rates are high.
However, as a real estate agent you definitely want to clear this with your office’s legal counsel BEFOREHAND. You definitely do not want to create liability. Your legal counsel may, as a minimum, insist on having additional disclosure and liability waivers signed as well as receive approval from the lender.
Like a seller carryback the terms of the land contract are completely negotiable. All of the terms I mentioned in seller carrybacks apply here. I also strongly encourage you to make use of an attorney when it comes to setting the terms of the land contract and completing the paperwork. In some states title companies can assist with these documents.
As we know, traditional closings can be very costly in terms of closing costs, especially for the buyer who has to pay loan origination fees. An advantage to selling with a land contract is that most of these fees don’t apply, saving thousands of dollars in closing costs. This means that the buyer can either put this money towards a down payment, or for the buyer whose funds are more limited, they are still able to get into the house when they might not otherwise be able to do so.
A land contract results in the conveyance of the property. Because of this the buyer is actually a buyer and not a tenant. This gives the seller the advantage of putting someone in their home that has a buyer’s mentality not a tenant’s. They are much more likely to take care of the house and be responsible than the average tenant. The disadvantage to this is if the buyer should stop making payments for some reason, in most states, the seller cannot simply evict them. They will either need to follow forfeiture procedures or foreclosure procedures, both of which cost more in time and money than a standard eviction.
On a land contract the seller can also “wrap” their mortgage. For example, if the seller is paying 5.5% interest, they might be able to charge 8% or more to the buyer. Even without much of a higher price on the home (which is great for sellers with little equity), you have the spread between 5.5% and 8.0%. On $100,000 of a loan balance, it would mean $2,500 per year in interest payments in the seller’s pocket! That’s 2.5% difference in interest on $100,000.
Land contracts hold a big advantage over seller carrybacks in that you are able to market to a much larger pool of buyers. With the seller carryback the buyer is still qualifying for a mortgage for most of the cost of the property, but the land contract reaches out to someone who is currently unable to get a mortgage, which greatly increases the buyer pool.
In the case of a land contract you might receive part of to all of your commission upfront if the buyer is able to front a down payment. Otherwise you would probably need to work out a payment plan with the seller where your commission is paid in installments over time.
Lease Option/Lease Purchase
Lease options and lease purchases are probably the most creative forms of seller financing and are particularly effective for selling homes in a down market. In both, the buyer is leasing the property from the seller for a period of time and at the end of the lease period they can buy the home for a pre-set price. In the case of a lease option, the buyer has the right to purchase the home, although if they don’t they would forfeit their option fee. In the case of a lease purchase the buyer is obligated to buy the home at the end of the lease period. Obviously as an agent representing the seller the lease purchase is more desirable. Despite being more desirable, however, it is more limiting which doesn’t always make it the best choice in a down market. You must make sure that if the buyer signs a lease purchase they can actually get a mortgage down the road, otherwise the seller will be suing them in court for specific performance (not a good experience).
Unlike the seller carryback and land contract, the seller is not charging interest on a loan; the tenant buyer is, instead, paying rent. One of the negotiable terms of the lease option/lease purchase contracts is whether any of the rent will apply as a credit towards the purchase price, otherwise there is no principal pay down.
With lease options and lease purchases the seller has a landlord-tenant relationship with their buyers until they actually purchase the house. This bears some advantages and some disadvantages. While the buyers are tenants, they do not have the typical tenant mentality. Their intention is to buy the house. As part of the lease option or lease purchase contracts they pay an option fee, which applies against the purchase price when they buy, but it is non-refundable if they don’t. This money helps keep them motivated to become home buyers. However, because they are tenants, during the lease period the seller will be responsible for repairs on the house, except of course for damage done by the tenants.
One of the main advantages to having the landlord-tenant relationship during the lease period is that if the tenant stops paying rent the seller can evict them. The reason is in lease options and lease purchases the seller retains ownership of the house until the buyer actually exercises the purchase agreement. While evictions are rare, they are definitely advantageous because they are much less costly and much quicker than foreclosure or forfeiture. Additionally, if a seller is forced to evict they still get to keep the option fee.
The terms of lease options and lease purchases are different than mortgage-based seller financing. Instead of negotiating interest, amortization and the like, they are negotiating things like:
- the length of the lease,
- the amount of the rent,
- the amount – if any – of the rent applied against the principal,
- whether extensions will be permitted
- how much, if any, the purchase price, option fee and rent will increase for an extension period.
Like land contracts, lease options and lease purchases are truly offering the home to the largest possible pool of potential buyers. Offering this kind of flexibility is the most effective way to sell in a down market.
As a real estate agent, typically you would receive a portion of your commission upfront paid out of the option fee and the remainder when the buyer actually completes the purchase on the home.
Mortgage assumptions are much more limited, but can be a useful option for down markets. Instead of obtaining a new mortgage the buyer assumes (takes over) the seller’s existing mortgage. Depending on how much equity the seller has in the property it may be necessary for the buyer to either make a down payment or for the seller to offer a second mortgage.
The reason that mortgage assumptions are more limited is because of the qualifying criteria that must be met. First, the existing lender must be willing to let a new buyer assume the mortgage. Most mortgages are non-assumable, however, given the challenged market conditions many areas are experiencing this may be negotiable with the lender. In order for the buyer to assume the mortgage, however, they must be able to qualify. The lender will not let just anyone assume it. If the buyer can qualify for the existing mortgage they can likely qualify for a new mortgage as well.
There are a couple of reasons a buyer might want to do a mortgage assumption versus just getting a new mortgage. First, the terms of the seller’s existing mortgage, such as interest rate, may be much better than the buyer can get on a new mortgage. If you remember from our above example, just a ½% rate differential on a much smaller loan can make a difference. The other reason a buyer would want to assume a mortgage is because it can save them thousands of dollars in closing costs. The advantage of this to the seller is that is means the buyer can put more money down when buying, or it allows them to buy when they might not otherwise have been able to.
Mortgage assumptions are much like seller carrybacks for real estate agents when it comes to getting paid their commission. If the buyer can afford a down payment you may receive some commission upfront. Otherwise you may need to structure a payment plan with the seller.
When working as a real estate agent in a down market it is critical to reach as many buyers as possible, whether listing homes or acting as a buyer’s agent. The typical pool of buyers is limited to those who can currently qualify for a mortgage. By offering creative solutions you are able to reach far more buyers than your competition, especially using lease options, lease purchases and land contracts. This allows you as an agent to do far more business than if you just did conventional sales.
Being a real estate agent in a down market can be tough. By utilizing some of these creative financing differentiates you from the pack of other real estate agents. As a buyer’s agent you’ll turn away far fewer potential buyers and as a listing agent your listings will reach a larger pool, helping you get homes sold. This means more sales and more commissions, allowing you to not only survive in a down market but actually thrive.
To find out more about this topic, visit my website at www.WendyPatton.com. My website offers free articles, my national speaking schedule and my new books, Rent-to-Sell, (published late February 2009) and Rent-to-Buy (coming out May 2009). You may also be interested in my other books, Making Hard Cash in a Soft Real Estate Market and Investing in Real Estate With Lease Options and “Subject To” Deals. These are books for sellers, buyers, investors and the real estate agents that serve them.
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