One of the most common questions raised – and one of the most difficult situations to wrestle with in an owner-financed deal is if there’s an existing loan on the property.
Once upon a time, many existing mortgages were assumable, meaning a buyer could simply take over the obligation to pay on an existing mortgage. In effect, they would become the new payor for that loan. This worked exceedingly well with owner financed deals.
With very few exceptions, those days are behind us, and most mortgages today have what is called a due-on-sale clause which makes them un-assumable because any remaining loan balance has to be paid in full at the time of sale.
In a subject to transaction, neither the seller nor the buyer tells the existing lender that the seller has sold the property and the buyer is now making the payments. The buyer did not obtain the bank’s permission to take over the loan. Lenders put special verbiage into their mortgages and trust deeds that give the lender the right to accelerate the loan in the event of alienation.
Do banks call these loans due and payable upon transfer? It depends. 99.9% of the time they do NOT. Most banks are simply happy that somebody—anybody—is making the payments. But the banks do have the right to call the loan because of the due to the acceleration clause in the mortgage or trust deed. If the buyer can’t pay off the loan upon the bank’s demand, the bank could initiate foreclosure. In reality, if the loan is current, the bank is happy. In the case of an FHA mortgage, HUD has to approve the FHA lender foreclosure, if the loan is current, they will not authorize the foreclosure action.
FHA loans allow for a traditional loan assumption but most conventional loans do not. Regardless, if the loan is current, the banks will NOT exercise the due on sale clause.
There are some tricky ways to try to subvert the due-on-sale clause and still set up an owner financed deal when the property has an underlying loan. All of these get into the realm of creative financing.
Here’s a quick rundown on 5 techniques for putting together owner financing if there’s an existing mortgage present:
1. Buying “Subject To” the Existing Loan
It means the seller is not paying off the existing mortgage and the buyer is taking over the payments and in many cases paying off the late payments and fees. The unpaid balance of the existing mortgage is then calculated as part of the buyer’s purchase price. The mortgage stays in the sellers name and the buyer makes the payments. These payments will rebuild the sellers FICO score.
2. Wraparound Mortgage
A wraparound mortgage creates one loan that is big enough to pay on the existing loan plus any additional equity in the property. With a “wrap” mortgage, you make this larger payment to the seller. In turn, you entrust the seller to pay the underlying mortgage. The difference between the two is the owner financing on the equity.
3. All-Inclusive Trust Deed
An all-inclusive trust deed is basically a wraparound mortgage. It’s a legal term used in many states to denote the same process.
4. Lease Option or Lease Purchase
With this approach, you actually lease the property from the seller with an option to buy, or a contract is already drawn up to buy, but at a later date. A lease-purchase agreement means the seller is leasing the property to the buyer, giving him an equitable title to it. Upon fulfillment of the lease-purchase agreement, the buyer receives the full title and typically obtains a loan to pay the seller, after receiving credit for all or part of the rental payments toward the purchase price.
This allows you to control the property and selling price until you can arrange for outside financing. Again, buyers need to be wary in case the seller fails to make their payments while the lease option is in effect. Typically a servicing company is utilized to to ensure the payments are going to the under lying lender.
5. Land Installment Contract
This is, perhaps, the most complicated of all forms of creative financing. With this approach, a contract is set up for the buyer making stipulated payments for a period time (5 to 10 years is common). Similar to a lease option, it allows the buyer to control the property and price until other financing can be arranged.
The real caution is that with a “land contract” the buyer has no vested interest in the title to the real estate. If they default on even one payment, the contract is terminated and the seller gets the property back without any need to foreclose.
The Dodd-Frank Act of 2010 Affects Owner Financing
In the aftermath of the subprime mortgage meltdown and all the predatory loans that had been issued prior to 2007, Congress enacted legislation that eventually became known as Dodd-Frank. It was aimed mainly at Wall Street, but politics allowed its scope to also blanket private sellers on Main Street who offer owner financing.
For the average seller, with a property or two for sale, the Dodd-Frank is of no real concern. However, it is best to utilize the services of a Registered Mortgage Loan Originator to qualify the buyer.
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