Many states have homeowner equity protection laws. It’s important to be careful about representing the value of a home. If you tell an owner their home is worth a certain amount and then flip it for significantly more, which is of course your intention, you may find yourself afoul of the law. You should rather state that you’re willing to offer that amount and make sure, in writing, that the owner understands that you’re reselling the property for a profit.
Be honest and ethical and focus on what you are providing for them that justifies a lower price, such as:
- Subject-to financing to bring the loan current and improve their credit
- Provide cash quickly
- Give the owner the ability to move quickly
- Avoiding the hassle and expense of clean up, repairs, or dealing with showings
Of course they could get more in a traditional sale, but they’re not in a traditional sale position.
Subject to Financing
One method of buying a house without cash or financing is to buy it subject to the existing mortgage. In a subject-to deal, the buyer takes title and assumes the payments, but doesn’t assume the loan, which remains in the name of the seller. The loan must be brought current, usually by the buyer since the seller is in financial distress, so some cash is required. In addition, the buyer usually offers an additional cash payment to the seller as an incentive, typically one or two month’s rent.
Benefits. A subject-to deal can be a quick way for an owner to get out of a bad situation with a little cash to use for relocation. For the buyer it offers a way to acquire property for little or no cash and no new financing, which bypasses the delay and potential problems associated with qualifying for credit.
Risks. Most residential loans have a due-on-sale clause that gives the lender the option of calling the entire balance of the loan when the property changes hands. It’s hard to fly under the radar on this because, as a distressed property, the account is already receiving special attention. Even if the lender doesn’t catch the change of title at the courthouse, they will receive notice of a new insurance policy under a different name and connect the dots. So the buyer could acquire a property for little or no cash, only to see the bank demand full immediate payment from the former owner and fast track the foreclosure. The buyer is out any cash paid to the sellers and any money spent bringing the loan current.
A wraparound mortgage is an alternative to subject-to financing that gives the seller more protection. In many cases the seller is reluctant to do a subject-to deal because the existing loan is still in their name and their credit is still at risk on that loan.
A wraparound is a seller-financing option where you as the buyer offer a mortgage to the seller. The seller takes your monthly payment and makes payments on the original lien themselves. If you fail to pay the mortgage, they can protect their credit by continuing to make payments to the original lien, and if you default, they can foreclose on you and get the house back.
Benefits. A wraparound calms the fears of a nervous seller unwilling to rely on another party to continue to pay a loan that remains in their name by allowing them to keep control of the original mortgage. Like the subject-to deal, a wraparound is a quick way for an owner to get out of a bad situation with a little cash to use for relocation. The buyer still has the advantage of little or no cash and private financing.
Risk. The wraparound transfers the risk from the seller to the investor. You paid to get their loan current and a little cash incentive. What happens when you make your payments but they default on the original mortgage again? The lender forecloses, the subordinate mortgage you placed with the seller is wiped out, the bank gets the house, and you’re out the up-front cash and any payments you made. In addition, wraparound financing has the same risk as any other sale, the due-on-sale clause found in most mortgages, under which the lender could call the full amount of the original mortgage due immediately upon sale, which would simply escalate the foreclosure process.
There are some cases where the owner wants to stay in the home and can proceed forward with payments on the loan, but can’t deal with the past-due payments. Perhaps a period of unemployment drained the owner’s reserves and she now has a new job but no resources to apply to the outstanding payments.
For those pursuing a hold-and-rent strategy, a lease-back option contract is a way to resolve the owner’s problem and acquire an income-generating property with no revenue downtime. The buyer offers the seller a lease-purchase/rent-to-own contract with a suitable down payment and the seller doesn’t even have to move.
Even in a fix-and-flip strategy, sometimes a lease-back can make sense. In a down market, you may find yourself with a property on your hands that doesn’t move at the price point you projected. Leasing back to the owners is one way generating income while waiting out the market until you can get the price that gives you the target ROI.
At the end of the negotiations you need a well-written contract that incorporates the laws of the state and is clear. You can’t be successful if owners come back after the sale and says you mislead them. Every good deal has benefit for both parties. You are helping them out of a tough spot. In exchange you’re buying the property at below market value with the intention of doing the required repairs and selling it for a profit. Make this clear in writing and have the owner sign it. Work only with owners who understand and agree to this mutually beneficial arrangement.
In all cases, thoroughly document the condition of the property before and after and cleanup or renovation. This establishes a basis for both the buying price and the selling price later on, which helps protect you from complaints from the former owners about being mislead.