Creative Financing Redux

It’s been quite a number of years since we’ve heard the term ‘creative financing’ and certainly many, many years since we’ve had to employ such techniques in our home sales arsenal, but recent events have us reconsidering their use.

Since the meltdown in the mortgage industry, many of the mortgage products we have come to expect are no longer available. For the most part, the economy is better off without some of these programs. For instance, who thought it was a good idea to allow folks with bad credit or no down payment to borrow large sums of money? Similarly, the ‘no documentation’ mortgage, in which very little supporting material was required, seemed to be asking people to commit mortgage fraud.

When taken to extremes their use abused the system, but there were appropriate uses of these products. For instance, a borrower with an 800 credit score but nothing to put down still represents a solid borrower. Additionally, a borrower with a low credit score but a very healthy down payment would represent a marginal risk. Unfortunately, common sense mortgage underwriting has given way to a series of mindless guidelines whose purpose is to create a universal decision process; a one size fits all, so to speak.

In any event, these types of programs have now been discontinued and a large number of the programs that remain have been significantly tightened up, resulting, occasionally, in situations where nothing available fits. It is under these circumstances that one may need to employ creative financing.

Whenever you hear the term ‘creative financing,’ you should understand it to mean ‘owner financing,’ as in most instances there is some level of owner involvement. It should also be understood that although creative financing may appear to be a panacea for your lending problems, you must realize that all forms come with some degree of risk.

First, let’s consider a ‘rent with the option to buy.’ This arrangement offers the least commitment from either party. In effect, what is being said is that the buyer is uncertain of their interest in the property, but it is greater than a mere landlord/tenant interest. So if at the end of a designated period of time the tenant would like to exercise their option to purchase the property, the landlord will sell it to them at a predetermined price, allowing a portion of the rent they have paid to be utilized toward the down payment. Everything is negotiable: the term, the price, the portion of the rent to be applied to the purchase. Nothing, however, obligates the tenant to purchase, so that at the end of the term the tenant can express no interest and the money paid during the lease is merely considered rent.

A second possibility is to allow the buyer to assume your mortgage. This is probably best illustrated by example. Say you’re selling your home for $150,000 and have a mortgage balance of $120,000. Your buyer would assume your payments on the $120,000 and the balance could be handled in one of three ways: the buyer could give you $30,000 cash; you could accept a note from them for $30,000, in which case you would need to set a repayment plan; or you could have a combination of the two, some cash down and the balance in a note.

The third option would be for you to hold a ‘purchase money mortgage.’ In this case, you are the bank. The buyer provides you with a down payment up front and monthly payments for a period of time. In this instance, you will actually transfer the property to your buyer by deed, and they will execute mortgage documents to you promising to repay the loan.

Finally, you could enter into a ‘land contract,’ the procedure which is similar to the purchase money mortgage. The major difference is that you will not transfer the title of the property to the buyer until they have fulfilled the terms of their contract with you.

The primary reason to use a land contract rather than a purchase money mortgage is the strength of the borrower. If a borrower has a substantial down payment and good credit, they will likely demand that the title be transferred to them. If however, the borrower’s credentials are weak, the seller may be reluctant to transfer the property, preferring to wait until the details of the contract have been fulfilled.

Now comes the fear factor. If you, as the seller of the property, have a mortgage against it, you must exercise caution as owner financing layered over an existing mortgage could violate provisions of your mortgage document, resulting in the foreclosure of your loan. It is advisable that if you are considering owner financing of any type, consult a good real estate attorney to guide you through the minefield. Properly utilized, creative financing can be one more tool to help you sell your property.

Gary Straub has been a real estate professional since 1970 and is a member of the Northwood Realty management team.