RELE 1319 Chapter 13
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RELE 1319 Chapter 13

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Chapter 13 PowerPoint presentation for Spring 2014 RELE class.

Chapter 13 PowerPoint presentation for Spring 2014 RELE class.

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RELE 1319 Chapter 13 RELE 1319 Chapter 13 Presentation Transcript

  • Financing Residential Real Estate Lesson 13: Seller Financing
  • Introduction This lesson will cover:  how seller financing works  why seller financing is used  forms of seller financing  alternatives to seller financing  agent’s responsibilities in seller-financed transactions
  • How Seller Financing Works Two ways for seller to finance buyer’s purchase:  purchase money loan  land contract
  • How Seller Financing Works Mortgage or deed of trust  Seller is extending credit to buyer, not providing loan funds.  Buyer makes installment payments to seller.  Seller is mortgagee or beneficiary, with right to foreclose in case of default.
  • How Seller Financing Works Contract for Deed Buyer (vendee) takes possession of property, but seller (vendor) retains title until contract price paid in full.  Alternative to a lien.  Seller extends credit to buyer.
  • How Seller Financing Works Seller financing may be:  primary financing  seller is buyer’s main or only source of financing for purchase  secondary financing (seller second)  supplements primary loan from institutional lender  covers part of downpayment or closing costs required for primary loan
  • How Seller Financing Works Choosing finance instrument Seller generally decides which type of finance instrument  Real estate lawyer should prepare/review.  Deed of trust: trustee must be appointed.
  • Why Seller Financing is Used Seller financing can:  attract buyers when interest rates are high  help buyer qualify for institutional loan  enable seller to charge higher price  provide tax benefits to seller
  • Why Seller Financing is Used Seller financing:  seller isn’t bound by institutional policies regarding yields, loan-to-value ratios, or qualifying standards  not an option for seller who needs to be cashed out quickly
  • Seller Seconds Seller second:  buyer paying most of purchase price with institutional loan  seller accepts second mortgage for remainder
  • Seller Seconds Supplementing a new loan Seller second supplementing new institutional loan must meet institutional lender’s standards. Combined loan to value (CLTV) Credit Income and debt ratios Assets (including reserves) Terms
  • Supplementing New Loan Buyer’s situation Factors in buyer’s financial situation may shape design of seller second:  funds available for down payment  buyer’s qualifying for total monthly payment  interest rate  balloon payment
  • Supplementing New Loan Buyer’s situation May be easy to refinance seller second with balloon payment if:  property has appreciated substantially  interest rates are low But if interest rates are high or property has lost value, refinancing could be difficult.
  • Supplementing New Loan Seller’s situation Seller’s evaluation of second:  cash at closing  monthly income  timing of payoff (balloon payment)  yield on investment  tax consequences  lien priority
  • Seller Seconds Supplementing an assumption Seller second can supplement buyer’s assumption of seller’s existing mortgage.  Buyer makes payments on seller second to seller.  Buyer takes over monthly payments on seller’s existing mortgage.
  • Seller Seconds Supplementing an assumption Assumption only possible if:  existing mortgage doesn’t have due-onsale clause, or  lender agrees to assumption.  Needed to release seller from liability.  Usual underwriting standards to evaluate buyer assuming loan.
  • Seller Financing as Primary Loan Unencumbered property Seller financing is most flexible when seller has clear title to property.  Buyer and seller negotiate price and terms  Buyer may need less cash  May not have discount points or origination fees  Lower closing costs
  • Unencumbered Property Protecting seller’s security First lien position if finance instruments are recorded. Seller should still be concerned with:  property taxes  special assessment liens  hazard insurance
  • Unencumbered Property Protecting seller’s security Failure to pay taxes or insure property should be grounds for default under the finance instrument.  Seller can require impound account.  If not, seller should require proof be sent to him.
  • Unencumbered Property Institutional second Buyer might want to supplement seller financing with secondary financing from lender.  Seller should investigate terms of proposed second loan before agreeing to transaction.  Can buyer afford monthly payments on both loans?  Does second have provisions that make default likely?
  • Unencumbered Property Contract for deed Seller may choose to use a contract for deed instead of mortgage or deed of trust. Also known as:  land contract  bond for deed  conditional sales contract  installment sales contract  installment land contract  real estate contract
  • Contract for deed How contract for deed works Seller (vendor) keeps title to property until buyer (vendee) pays off entire purchase price in installments.  Legal title: vendor’s title during contract term.  Equitable title: right of vendee to possess and enjoy property.
  • Contract for deed How contract for deed works Contract:  not accompanied by promissory note  states all terms of sale and financing arrangement between vendor and vendee  should always be recorded
  • Contract for deed Remedies for breach of contract Forfeiture: penalty if vendee breaches contract.  Vendee’s rights in property are terminated.  Payments may be kept by vendor as liquidated damages.  Vendor may retake possession of property immediately.
  • Contract for deed Remedies for breach of contract In Texas, repossession not allowed 40% of the amount owed OR has made 48 monthly payments Trustee must be used to sell property instead
  • Contract for deed Remedies for breach of contract Vendee refusing to leave means legal action to clear title and remove vendee from property.  Drawback for vendor: may take months.
  • Contract for deed Remedies for breach of contract Judge may:  enforce contract as written  give vendee time to pay off contract balance  allow vendee to reinstate contract by paying delinquent payments plus interest  order sheriff’s sale of property
  • Contract for deed Advantages and disadvantages Advantages for vendor:  legal owner until contract paid in full  may reacquire property in event of default
  • Contract for deed Advantages and disadvantages Disadvantages for vendor:  delay and expense of court proceedings  uncertainty of trial results
  • Contract for deed Advantages and disadvantages Advantages for vendee:  slow court proceedings
  • Contract for deed Advantages and disadvantages Disadvantages for vendee:  vendor remains legal owner  judgments against vendor might cloud interest  uncertainty of court decision
  • Contract for deed Using a contract for deed Lenders generally don’t permit financing to vendees due to the nature of the ownership Two possible solutions:  Vendor agrees to have property stand as security for institutional loan.  Vendee could mortgage his equitable interest in property.
  • Contract for deed Using a contract for deed Vendor agrees to have property stand as security for institutional loan.  Vendor doesn’t assume personal responsibility for repayment.  Lender can foreclose on property but can’t sue vendor for deficiency.
  • Seller Financing as Primary Loan Encumbered property Seller of encumbered property can’t afford to pay off existing mortgage at closing.  Seller second was one alternative.  Wraparound financing is another alternative.
  • Encumbered Property Wraparound financing Wraparound financing:  property remains subject to underlying loan  buyer does not assume underlying loan  seller remains responsible for payments  buyer makes monthly payments to seller  seller uses part of buyer’s payment to make payment on underlying loan
  • Wraparound Financing Choice of finance instrument For wraparound, seller can use:  mortgage  deed of trust  contract for deed Deed of trust used for wrap: all-inclusive trust deed.
  • Wraparound Financing Underlying loan: no due-on-sale clause Wraparound financing is only proper if underlying loan doesn’t have due-on-sale clause and lender approves of it.  Silent wrap: without lender’s consent.
  • Wraparound Financing Compared with assumption + second If seller’s existing loan has no due-on-sale clause, parties can choose between:  assumption plus seller second  buyer gets benefit of existing loan with below-market interest rate  wraparound  may give buyer below-market rate and seller above-market yield
  • Wraparound Financing Seller’s yield Seller’s yield depends on:  amount of credit extended to buyer, and  difference between interest rate on wrap and rate on underlying loan. Credit extended is:  difference between wrap amount and balance on underlying loan  not full amount of wrap
  • Wraparound Financing Seller’s yield Example: Sales price: $200,000 Downpayment: $20,000 Underlying loan: $150,000, balance at 6% interest Wraparound: $180,000 at 7.5% interest $180,000 Wrap financing for buyer – 150,000 Seller’s underlying loan balance $30,000 Credit extended to buyer
  • Wraparound Financing Seller’s yield Example, cont. In first year:  Seller collects $13,500 in interest from buyer.  Seller pays $9,000 in interest on underlying loan.  Net interest to seller: $4,500. Net Interest ÷ Credit Extended = Seller’s Yield $4,500 ÷ $30,000 = 15%
  • Wraparound Financing Protecting wraparound buyer To ensure seller makes payments on underlying loan:  provision in finance instrument requiring seller to make timely payments, and allowing buyer to pay lender directly if seller defaults  “Request for Notice of Delinquency”  escrow account managed by third party
  • Alternatives to Seller Financing Seller can help with:  buydown  contribution to closing costs  equity exchange  lease/option  lease/purchase
  • Alternatives to Seller Financing Buydowns Buydown: seller pays to reduce buyer’s interest rate on loan.  Seller proceeds are reduced by amount of buydown.  Buyer more easily affords lower payment and/or qualifies easier with lower DTI
  • Alternatives to Seller Financing Contributions to closing costs Seller sometimes willing to make up shortfall when buyer doesn’t have enough money for closing costs.  Lenders impose limits on amounts.
  • Alternatives to Seller Financing Equity exchanges Seller may be willing to accept other assets from buyer and reduce cash sales price.  Equity in vacant land or personal property.
  • Alternatives to Seller Financing Lease arrangements Sometimes buyer wants to lease home before actually buying it.  Time to get cash for closing or downpayment.  Cannot currently qualify for loan.
  • Alternatives to Seller Financing Lease arrangements Seller can lease property to prospective buyer in one of two ways:  lease/option arrangement  lease/purchase arrangement
  • Lease Arrangements Lease/options Lease/Option: lease agreement includes option to purchase.  Seller leases property to buyer for term.  Buyer granted option to purchase property at certain price during lease term.  Seller = Landlord/Optionor  Buyer = Tenant/Optionee
  • Lease Arrangements Lease/options Lease/option:  buyer has no obligation to buy  seller can’t sell property during option period  can be used even if seller’s loan has due-on-sale clause
  • Lease/Options How lease/option works Lease/option:  buyer pays seller option money to make option binding on seller  option money not refundable  option money may be applied to purchase price if buyer exercises option  rental payments may be applied to purchase (rent credit)
  • Lease/Options Rental payments Rent charged on lease/option is often higher than rent under ordinary lease.  Gives optionee incentive to exercise option quickly.  Provides compensation to optionor for uncertainty of outcome.  Permits a lender at the exercise of the option to credit excess toward down payment.
  • Lease/Options Rent credit Three ways rent credit can be applied to purchase:  applied to down payment  deducted from sales price  applied toward closing costs/prepaids
  • Lease/Options Provisions of lease/option agreement Lease/option should:  include all terms of lease  include all terms of potential purchase contract  state that option money is not security deposit  state that option rights are forfeited if tenant defaults on lease  state that option money is forfeited if purchase is not consummated by buyer
  • Lease Arrangements Lease/purchase Lease/Purchase: purchase contract allows buyer to lease property for extended period before closing.  Parties sign purchase agreement (not option) along with lease.  Tenant/buyer provides good faith deposit instead of option money.  Closing date set quite far off; buyer rents property in meantime.
  • Lease Arrangements Lease/purchase If tenant/buyer decides not to buy property, good faith deposit is forfeited.  Tenant/buyer probably more committed with lease/purchase contract than with lease/option.  Eventual sale more likely.
  • Agent Responsibilities Real estate agent should:  make sure both parties understand seller financing arrangement  encourage both to consult lawyers or CPAs  never prepare seller financing documents
  • Agent Responsibilities Disclosures Seller financing disclosure:  required in some states when agent helps arrange seller financing  discloses all financing terms  informs seller of buyer’s financial situation
  • Agent Responsibilities Disclosures Good idea to use disclosure statement even if not required by state law.  Provides information to parties.  Protects agent by documenting that certain information was provided.
  • Agent Responsibilities Liability Disclosure statement does not completely shield agent from liability.  Breach of fiduciary duties.  Inadvertent dual agency.