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Part 3 Buying Property with Little or No Money Down

Part 3

Buying Property with Little or No Money Down

Creative financing has been and still is being used by sophisticated real estate investors for the many benefits that are a part of the warp and woof of it's very nature. The Donald Trumps of this world have always used techniques that are anything but conventional. Recently, however, the average investor has come to rely on creative real estate financing as a way to avoid the cost of borrowing money from institutional lenders and the strict qualifying requirements of conventional loans.

Some people assume that "no money down" means the seller doesn't receive any cash. This is not always the case however. Many deals can be structured in ways that allow the seller to walk away with cash but the cash does not have to come from your pocket.

Technique 1

Lets say a seller has a property with a fair market value of $50,000 and an existing assumable mortgage of $30,000 at 8% interest with payments of $245 per month. The seller's equity is $20,000 ($50,000 minus $30,000).

A conventional "no money down" way to purchase the property would call for the buyer to assume the first mortgage of $30,000. The buyer then would give the seller a second mortgage for the $20,000 balance at 10% interest with payment of $200 per month. The purchaser's total payment would be $445 per month ($245 + 200).

In order to avoid the cost and liability of assuming the existing mortgage, offer the seller a $50,000 wrap-around mortgage, payable at the rate of 10% interest with payments of $445 per month. On the surface, it appears to be the same proposition, but look at the difference.

A wrap-around mortgage is a new mortgage which literally "wraps" around the old mortgage. By using a wrap-around mortgage, the buyer makes payments on the old mortgage. Since the payments on the new mortgage are larger than on the old mortgage, the seller keeps the differences.

In this example, you will pay the seller approximately $5,000 per year interest ($30,000 x 8%) on the first mortgage. The seller will keep the difference, or $2,600 per year ($5,000 minus $2,400). The seller's equity is $20,000 so the seller is actually netting approximately 13% ($2,600 divided by $20,000) on the transaction, and the first mortgage is being paid off at a faster rate than the wrap-around mortgage. Therefore, when the first mortgage is paid off in fifteen years or so, the wrap-around mortgage will have an unpaid balance of about $35,000. The seller's equity has effectively grown from $20,000 to $35,000 which is good for both parties.

Technique 2

On this one you would create a promissory note and mortgage on the existing equity you have in an asset (home, boat, investment property, automobile, vacant land, etc) and use it as a down payment on another property. Equity is the value of the property minus any mortgages or liens.

Assume that you located a two family property that is on the market for $60,000 with an existing $25,000 mortgage. Therefore, the seller's equity is $35,000. You now create a promissory note and mortgage in the amount of $15,000 secured by equity in one of your assets. Use that as a down payment on the two family property and ask the seller to take a $45,000 wrap-around mortgage for the balance. When you buy the two family property, you will immediately have $15,000 equity in the property because of the $15,000 down payment.

The mortgage that you are creating on your asset should have a substitute of collateral clause, allowing you to later move that mortgage from your asset to another property where you have equivalent or greater equity. Thus, you might use equity in your own home to buy investment property "A"; your equity in "A" to buy "B"; your equity in "B" to buy "C"; and then, by the substitution of collateral clause, move the mortgage from your own personal residence to your most recent purchase, property "C". If the seller of the two family property, property "A", is concerned about not receiving any cash at the time of closing, the note and mortgage can be converted into cash by selling them to someone else.

Technique 3

The seller might be willing to sell "no money down" and take back a mortgage for the entire equity of a property. However, the seller might be afraid that you will walk away from the property before building up a substantial equity, forcing the resale of the property all over again. If this happens, the seller may be fearful of getting the property back in a condition worse than when it was sold to you.

You can overcome the seller's fears by offering additional collateral with a blanket mortgage. A blanket mortgage includes more than one property. You can include equity in your home, other property or even an automobile under the terms of a blanket mortgage.

NOTE: the blanket mortgage that the seller will be taking back may be for a term as long as five or ten years. Since you do not want to tie up your extra property for that period of time, make certain that the mortgage contains terms that will allow you to release your home or other property from the mortgage after you have made payments on time for a period of six, 12 or 18 months.

Technique 4

A good source for capitol to help a new investor begin can be found in the investor's own home or investment property. Many lending institutions make loans secured by the equity in your home or other properties, usually for about 75% of their value. If you look for special offers, you can get as much as 80% to 85%. The interest rate is usually tied to the prime rate: for example, prime rate plus 1% or 2%.

The payoff period, or time in which the investor is required to repay the loan, is five to fifteen years, depending upon the lending institution. Most institutions do not charge any points (the percentage of the loan that the borrower must pay to the bank) for making the loan. In addition, the origination costs of the loan are very small.

Technique 5

This technique works well when the seller owes nothing on the property or when the amount the seller owes is not greater than 40% of the value of the property; however, you must have a flexible seller who is willing to help finance the property.

For example, assume the seller of a $50,000 house has an existing loan of $12,000 is looking for a $15,000 down payment and is willing to carry the financing for the balance of $23,000 ($50,000 minus $12,000 minus $25,000). Simply obtain a new first mortgage for $27,000 which can pay off the existing $12,000 mortgage and give the seller $15,000. Next, give the seller a second mortgage in the amount of $23,000. The $27,000 first mortgage plus a $23,000 second mortgage gives the seller his or her total asking price: $50,000

A seller who may be initially reluctant to accept this offer may ultimately agree to accept an offer with more cash up front. For example, obtain a new loan in the amount of $5,000, giving the seller an $8,000 larger down payment than expected, or a total of $23,000 ($35,000 new mortgage proceeds minus $12,000 old mortgage pay-off).

Some sellers have even been known to join the buyer in signing a note and mortgage at the bank. If the buyer does not have sufficient credit to get a new mortgage, the seller in effect loans his or her credit to the buyer.

Technique 6

A higher interest rate may encourage the seller to accept terms that would otherwise be unacceptable. This technique could allow a seller to postpone a portion of capital gain that might otherwise have to be reported in an installment sale under the new tax law.

For example, a seller has a property for sale at an asking price of $100,000. The property has an existing assumable mortgage of $50,000 payable at the rate of $450 per month. The seller wants $10,000 cash at close and will extend you a loan of $40,000 in the form of a mortgage at 10% interest.

Offer the seller $95,000 with no money down. Agree to take over the loan of $50,000 and pay 15% interest on the remaining $45,000 for a period of five years. The result is a monthly interest payment of $563 ($45,000 x 15% divided by 12 months) to the seller. You initially pay only the interest with $45,000 due in five years.

If the total monthly payments for the first and second mortgage of $1,013 per month ($450 + $563) result in a negative cash flow, restructure the second mortgage so that only a portion of the 15% interest is paid monthly. The balance would be accumulated but not compounded and would be due along with the $45,00 at the end of five years.

Technique 7

From time to time you will come across a property listed by a broker that is being offered for a 10% down payment. Typically the seller is asking for the 10% to cover the broker's commission as well as closing costs.

Brokers’ commissions are generally 5% to 7% of the purchase price. If a broker both lists and sells the property, the broker receives the entire commission. If another broker is involved, then usually this commission is split 50/50.

Borrowing a portion of the commission or giving the broker a portion of the ownership in lieu of all or part of the commission is sometimes possible, especially when dealing with a listing broker. If the listing broker is also the selling broker, the commission will not be split and the broker will be in a better position to loan part of it to you.

If you find some initial reluctance from the broker, you might try to make the proposition more attractive by offering to give the broker a note for an amount larger than the commission. For example, if the broker's commission is $5,000, you might consider offering a $6,000 promissory note of 1% per month. In other words, every month you would make a payment of $60 to the broker. At the end of the year you would have reduced, or amortized, the note by 2% or $120. The note could become due and payable in five to seven years. Generating all or part of the down payment in this way is a inexpensive way to do it.

Before approaching an agent or broker about borrowing commission, it is important to understand how the commission is determined in a real estate office. When a seller lists a piece of property with a broker, the broker's compensation is spelled out in the contract. It is usually computed as a percentage of the total selling price. Similarly an agent or salesperson has an agreement with the broker that sets the amount of commission received by the sales person when a transaction is completed. The rate of a broker's and salesperson's commission is always negotiable.

Another way of doing business is the Re/Max method and is one of the best ways to exercise this creative financing technique. Re/Max is a nation-wide brokerage firm that rents office space to its agents. In addition to rent, they also must pay a fee for the benefits of advertising done by Re/Max. The agent receives 100% of the commission on property sold. These agents and brokers are usually more receptive to lending all or a part of their commission to you than the more traditional agents and brokers. Check with your brokers to find out about the commission arrangements for his or her salespeople.

Technique 8

Lets assume you locate a property that is on the market for $50,000 and it has an existing $40,000 assumable mortgage. The seller's equity is $10,000 which is the down payment required to buy the property. The property has been on the market for four or five months without selling and the owner is getting anxious. Offer the seller $6,000 cash contingent upon being able to locate a new second mortgage. If the seller accepts that, you will proceed to find a lender to loan you $6,000 in return for a mortgage.

Banks and savings and loans are reluctant to take second mortgage loans on investment property like this because the property already has a loan for 80% of its value. Therefore, you will probably have to go to a private lender. Check the classified ad section in your local newspaper. You will find that there are private lenders who advertise that they will buy mortgages for cash. Call one of these lenders and tell them that you have a property that is appraised for $50,000 (if it is), has an existing $40,000 first mortgage on it, and you are in need of $6,000 cash. Ask them how large a note and mortgage would have to be and what the interest rate and term would be for them to give you $6,000. Assume they respond by telling you they would need a $7,500 note and mortgage at 12% interest for a term of five years. You would then determine, by doing a financial analysis of the property, whether or not the net operating income would support the payments on this new second mortgage and assuming the existing mortgage. If it does, you would proceed with the translation and, in effect, buy the property "no money down."

Other No Money Down Techniques

Some sellers are in a position where they are not able to sell their properties unless they actually receive cash at the closing. If you are using one of the techniques that does not allow the seller to receive cash, you might not be able to buy the property unless you can show the seller how to convert the note you are offering to cash. Let us look at several ways that the seller might accomplish this.

  • Technique A
    An active market of investors is eager to purchase notes at a discount. While this is probably the least desirable way to generate cash, selling a $10,000 note for $7,000 to $7,500 is not difficult, depending upon its interest rate and term. This process is known as discounting a note.
  • Technique B
    The note could be taken to a bank, with whom the seller has a good banking relationship, and pledged as security for borrowing money. While the seller will probably be paying 3% to 4% more for the money than what is being received from you in interest. This way is still much less expensive to generate cash than selling the note at a discount.
  • Technique C
    Let us say that you have purchased a property and have given a $10,000 promissory note to a seller secured by the real estate that you purchased. If the seller does not need the entire $10,000 or even as much as would be received if the note were sold at a discount of 30% to generate $1,400 in cash, another new note for $2,000 could be used by the seller as a down payment to buy real estate. The seller would still have the original note for $10,000. $6,000 of that note would be "free" and would generate income for the seller.
  • Technique D
    Most people are aware that when they receive a note, they have an asset in the amount of the note. What most people do not realize is that they really have two assets: they have the note itself and also cash flow that is coming each month or each year from that note.
    Assume that you gave the seller a $10,000 promissory note bearing interest at 9%, payable $900 per year. That $900 per year income that the seller is receiving could be sold at a discount, or for that matter, the seller could sell several years of income at a discount to generate cash. This technique would leave the primary asset, the $10,000 note itself, untouched.

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