Well-Being, Wealth, N More

What a title for an article! I was reading an article from Rich Dad’s Blog titled, “The Art of Creative Financing: Using the Seller as a Financing Source.” I’m not sure whether you know Robert Kiyosaki. He is the author of this article as well as Rich Dad Poor Dad and The Conspiracy of the Rich (both of which are Best Sellers). Robert also utilizes his expertise to teach people how to invest in real estate and prosper. Rich Dad Coaching is available to everyone at a reasonable price.

The article came from the Rich Dad Education Blog on March 2nd. Most of us are aware of traditional financing when we buy a home. We go to the bank or credit union and qualify for a conventional loan, a 30 year fixed rate mortgage. A fixed rate mortgage is the best type to have because you don’t have to worry about the interest rate changing.

When I bought my first townhome with 3 bedrooms and 2 baths, I qualified as a single parent for an adjustable rate mortgage (ARM). This was more than 30 years ago. I was told that the interest rate was low in the beginning, which would keep the payment within reason. However, there was no guarantee that the interest rates would stay low. When the interest rate changes, the payment on an ARM changes with it. The salesman told me that the interest rates could go up or down. Have you ever known the payment on an ARM to go down? Me either.

Two years into this ARM mortgage, I was given the opportunity to change to a conventional 30 year fixed rate loan. Needless to say, I changed immediately. The interest rates had not gone up, which gave me the opportunity to get a decent fixed interest rate at a payment I could afford. Adjustable rates as well as fixed rate mortgages are available to people investing in property in addition to other means of financing, which Robert Kiyosaki calls, “Creative Financing.” Sources of Creating Financing include:

• Other Investors
• Partners
• Hard-Money Lenders
• The Property Itself
• The Seller
• The Realtor (If one is involved)
• The Buyer
• The Renters (If it is an existing rental property)
• Options and Leases
• Underlying Mortgages
• Special First-Time Home-Buyer Programs
• Down-Payment Assistance Programs (For those who qualify)
• Your Rehab Contractor
• Your Local City, County, or State Government (Special loan programs)
• Government Grants
• Private Grants (For special projects)
• Relatives or Friends

According to Robert, this is not a complete list by any means, but it should give you a few ideas.

One of the most popular ways to finance a property (other than through a traditional lender) is to use the seller as a source of funding. If the buyer/investor has done his selection job well, he/she will be dealing with motivated sellers who will most likely be flexible with financing arrangements, as long as their needs are met. If the investor is in tune with the seller’s situation, they can develop a trusting relationship with the seller. The investor can then educate the seller as to the advantages of seller financing, and suggest ways to set up the financing that will create a win-win situation.

Here are a few ways that the seller can get involved in the financing:

1. Seller Funds the Whole Deal – If the seller owns a property free and clear, he/she can carry a mortgage for the entire purchase price of the property. This allows investors to get into the property for only enough money to cover their share of the closing costs. A sweet deal if you can get it! However, the investor may have to come up with some down payment. The amount would most likely be proportional to the amount of trust the seller has in the investor. Listen to the seller and find out what his/her needs really are and try to meet them.

Many times, especially for older sellers, the need is for a steady monthly cash flow and not for a lump sum of cash. Once they understand that it can be to their advantage to become the bank and they trust you, the deal is done. The buyer makes one mortgage payment directly to the seller. No banks involved.

2. Seller Funds Part of the Deal by Carrying a Second Mortgage – In the case where the seller has a mortgage on the property, but also has some equity, the seller may be willing to help with the financing by carrying a second mortgage on the property. For example, if an investor offers $200,000 for a property and the seller has a $100,000 first mortgage, the seller may be willing  to finance all or part of their $100,000 equity by creating a new mortgage that will be in the second position.

The buyer would obtain traditional financing in the amount of $100,000 to pay off the first mortgage. The seller would get a note (secured by the property) instead of cash at closing. If the seller is willing to carry all $100,000 on a note, the investor would have close to a nothing-down deal. He may have to come up with money for closing and finance costs. Or the seller may require a down payment for enough to pay the closing costs and a real estate broker fee, if a real estate agent is involved in the transaction. Always ask for a 100 percent second – you just might get it. In this case, the buyer would be making two payments – one to the bank for the new first mortgage and one to the seller for his $100,000 2nd mortgage note.

3. Seller Funds Part of the Deal by “Wrapping” the First Mortgage – If the seller is willing to create a note and take payments for the equity, but the buyer can’t get a new first mortgage (or doesn’t want to go to the expense of getting a new first mortgage), the seller can create a new note for the entire purchase amount that “wraps” the existing first mortgage.

In states using trust deeds, an all-inclusive deed of trust is the document that is used to create a wrap mortgage. As in the previous example, if the investor is paying $200,000 for the property and there is an existing first mortgage of $100,0o0, a new note would be created for $200,000, payable to the seller. But the note and mortgage documents would indicate that there is already a $100,000 mortgage on the property. The payment on the new $200,000 note would be based on the interest rate and term negotiated. The buyer would make one payment to the seller, but the seller would have to take part of those funds and make the payment on the first mortgage. The prudent investor would set up payments going to an escrow company that would make the payment to the bank and send the balance of the payment to the seller.

The wrap mortgage benefits both the buyer and seller. The buyer saves the origination expense of getting the new loan and usually gets an interest rate lower than he could get at the bank and gets into the deal for nothing down. The seller gets a quick closing (no waiting for any loans to be approved). If he’s smart, he will set up the interest rate on the new note to be higher than the interest rate on his original first mortgage. Thus, he will not only make interest on his equity, but make interest on the spread between the new note and the bank mortgage interest rates. This can be a great selling point to get the seller to accept the wrap-mortgage concept.

4. Seller Takes Second and Third, Keeps Third and Sells Second

In this situation, the seller wants some cash, or wants more cash than the buyer has to offer. For example, let’s say a buyer offers $200,000 for a home that has an existing $100,000 mortgage. The seller is willing to carry a second mortgage, but wants a minimum of $20,000 cash. The investor could get a new $100,000 first mortgage, pay the $20,000, and have the seller carry a note for $80,000.

What if the investor doesn’t have the $20,000? Is the deal dead? No. If you are dealing with a motivated seller, suggest that two notes be created-one for a $25,000 second mortgage, and one to the seller for their $75,000 third position note.

For ease of management, payments could be set up through an escrow company, so that the buyer would only have to make one payment to the esecrow company who would, in turn, pay the three mortgage holders. Second-position seller carry-back notes can be sold for less of a discount than third position notes; thus, the second position note was sold in this case.

5. Seller Carries a Second Position Note with a Balloon Payment

So far, the examples have been where sellers were willing to carry notes that were fully amortized over the negotiated term of the loan with no balloon payments attached. But many times, sellers may be willing to carry notes, but not for 20 to 30 years. They may be willing to accept payments based on a 30-year amortization period, but want the full balance to be paid off in a shorter period of time. This becomes another negotiating point in structuring the deal.

The seller may want a balloon payment of the entire balance in say, three to five years. This means that the buyer would have to sell the property or refinance in three to five years. Short balloons like these create high risk for the buyer/investor. Try to avoid balloon payments altogether, but if a balloon is the only way to save the deal, try to get at least seven to ten years before the balloon is due. Longer balloons give you more flexibility in finding the best long-term financing for a rental or give you a more saleable property if you sell and let your new buyer assume the existing seller financing.

6. Graduated Payments as an Alternative to a Balloon – Suppose you buy a property to keep for a long-term rental. The seller is willing to carry a note for some or all of the equity, but wants a balloon payment down the road. You may be able to eliminate the balloon (or at least reduce the balloon payment amount) by negotiating graduated payments into the deal.

For example, if the seller carries a note for $100,000 at six percent interest, amortized over 30 years, the payment for principal and interest would be $599.55 per month. If the seller insists on a five-year balloon payment, the payoff in five years would be $93,054.36. Now, if you had to refinance for that amount to pay the balloon in five years, could you do it? Maybe, but it also might be a foreclosure just waiting to happen. Instead of taking the risk of a short term balloon, why not try to negotiate graduated payments. Payments could go up $50 a month in the second year and subsequent years, the normal payment of $599.55 per month the first year, the $649.55 per month the second year, and so on. The increased rents should take care of the increased payments.

If you could get the seller to take the graduated payments and put off the balloon till year 10, then the payments would be $1099.55 per month. The balloon payment due would be around $50,000. This is a more manageable amount to refinance, even if the property didn’t increase a lot in value. This deal is much less risky for the investor.

The information presented was taken verbatim from Robert Kiyosaki’s Rich Dad Blog. He presented this information and identified these different ways to structure a deal. He goes on to say that it is important to find out what the sellers really need out of the deal, and be creative in giving them what they want. Of course, the numbers have to make sense to start with and allow the investor to make a profit from a quick sale or a positive cash flow from a rental. The more creative techniques you are familiar with, the easier it will be to successfully negotiate a winning deal for all parties involved.