What do you do when you’ve got a buyer for your property and for whatever reason, when it comes down to it, they can’t get approved for financing? Interestingly, I’m in the middle of this exact scenario on one of my houses right now. Unfortunately, there are numerous buyers out there right now that have pre-approval letters that aren’t worth the paper they are written on. Too many loan officers are willing to give marginal buyers false hope that they can get their loan approved without even talking to an underwriter first.
In fact, it’s been my experience that many loan officers will continue to project assurance that a loan will get approved while knowing good and well it’s got a minimal chance of getting final approval from an underwriter. While this may seem harmless enough, it can wreak havoc on sellers who are banking on the property selling. This was actually the topic of an article I wrote a few weeks back regarding the risks associated with repairs and upgrades performed for a buyer prior to closing.
As is the case with the property I am selling now, I’ve made a handful of repairs for this buyer prior to closing because the loan officer assured us that it was going to close. As I am two months down the road with this buyer as well as invested in specific repairs, I am not very inclined to cancel the contract and start over. Luckily, the buyer is highly motivated to get into the property and is willing to put a substantial amount of money down in order to accomplish this.
Having done a number of lease purchase transactions over the years, it isn’t a difficult decision make. While I would prefer to have the property sold now, it is actually possible to structure the lease purchase in such a way as to make more money on the deal in the long run. At the same time however, you’re helping the buyer get into the property they want now while working towards getting final approval on a loan. To me, real estate investing is always better when all parties involved feel like they’ve won.
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Structuring the Lease Purchase
When structuring the lease purchase for a buyer, I like to create an incentive for the actual purchase to go through sooner rather than later. As such, I’ll make the purchase price gradually ratchet up over certain increments of time (ie. 6 months, 9 months, 12 months, etc). This way, they buyer is motivated to work on the loan and finalize the purchase as soon as possible.
If the buyer had assumed they were approved for financing, the buyer also probably had the down payment saved or accounted for. As such, I like to collect this as non-refundable option money. With this kind of skin in the game, the chances of the buyer walking away are greatly reduced. When the buyer does eventually purchase the property, this money is credited as actual down payment funds towards the loan.
When it comes to figuring out a monthly payment, I’ll typically keep this in line with comparable properties in the area. Ideally, this is an amount that creates decent cash flow in the meantime. Also, the rent amount is typically going to be more than the buyer’s eventual mortgage amount. As such, this also creates an incentive for the buyer to execute the purchase quicker.
Even if the lease purchase isn’t your first choice in exiting a property, it can be an effective strategy when the initial purchase transaction falls through. Having it as a backup plan is a great way to preserve profit and potentially create more!