How to finance the first rental property

Question

Hey everyone, my business partner and I are trying to get our foot in the door with our first rental property. The single-family home we are looking at purchasing is currently owned by my business partner's father. He has been through the wringer it seems with this house. He took out a HELOC back in 2014 and has a balance of about $117,000 left on it. At that time, the house was valued at about $250,000. We plan on doing some renovations to the house to hopefully drive the value up. Since we have a bit of unique situation, my business partner's father wants to sell us the house, but for a discount. Our agreed upon sale price is going to be about $215,000. This will pay off the HELOC in the amount of $117,000 and the rest of the funds will be swung right back to my business partner and I to do those renovations. The rest of the equity in the house would then be purchased over time in an under-the-table deal between our business and my business partner's father. I feel like this would be a decent plan, except there is a twist. My business partner's father, the homeowner, filed for Chapter 13 bankruptcy a few years after he took out the HELOC. Long story short, he owes about $18,000 on the bankruptcy and once that is paid, the filing will be discharged. The sale of the house cannot legally go through until that filing is paid off in full. I know with this twist thrown in, it is probably not the ideal first rental property, but seeing as we would be purchasing for a discount, we still want to try to make it work. My business partner's father does not have the funds to pay off the $18K but we want to make a move ASAP. We would need to pay off that bankruptcy balance for him. We are trying to come up with ways to finance the whole thing. Some options have been thrown around such as using our personal funds to pay off the $18K, or taking a personal loan for the amount, then adjusting the mortgage to pay that off. Either way, that $18K will come out of my business partner's father's portion of the equity. Again, i know this is a unique situation but does anyone have any advice on how we could finance both the bankruptcy balance and structure the mortgage so that this could work? Any advice is appreciated. Thanks!

Dan M. · Answer

My original thought is find a competent attorney and do it all legit. They will know what to do. I'm guessing you will write a promissory note for the 18k with interest , then after the closing that will be paid back. The amount that the father loans to you again could be a promissory note or a lein against the property ( maybe? I'm not sure what bankruptcy allows ) at whatever interest rate you guys negotiate. Just do it all legit so there's no title issues when and if you decide to sell.

Matthew Dekker · Answer

The current value according to Zestimate is around $250K. We have budgeted around $80K for renovations. The issue with the $18K is that no sale can happen until that $18K is paid off to discharge the bankruptcy. The court will not allow that money to be apart of any terms of sale. Basically, because of the bankruptcy, any change in circumstance (which a sale of a home is considered) would cause the entire bankruptcy balance to be paid which would be around $50K. Therefore, paying off the $18K first and having the rest discharged by the court is the more cost effective option. We would not be moving in to this property. The plan is to use it as a rental property. The main issue is coming up with the $18K in some way, whether it is a personal loan or from savings and then how to account for that in the mortgage. We just do not want to make a stupid financing decision especially in a situation as unique as this one.

Axel Meierhoefer · Answer

There are a number of important items missing to really help you.

1. You said you and your business partner want to buy a house from his father. If that house was originally purchased in 2014 it would be helpful to get the current value, even if you use Zestimate.

2. If the house is in bad shape you should identify how much of an investment for renovation it will probably need (include some hourly rate for your work into it even if that is not actually paid and include work estimates for anything you can't do yourself). You want to end with a current value versus after repair value

3. The issue with the $18000 makes no sense to me. You can pick any price between $117K + $18K and the current value including closing costs, etc. You want to figure out that number. If you also want the money for the renovation to be included, you add that too.

4. With the values/numbers above the use case becomes important. Do you want to move into the property yourself, or your partner or do you plan to rent it out or resale it? Just as an example. If you wanted to rent it out after reno, I can connect you to one of my lenders who does 90% ARV mortgages that have a certain structure to me the first 5 years of the loan really cheap to payout of the rent and have extra money to lower the principle if you can or want. If you want to move in yourself, its a totally different ball game regarding interest rates and down payment, etc.

There are a few more things but these would really need to be answered to have a chance to help you

Matthew Dekker · Answer

Thanks for the reply! We definitely want to do it all legit. Our biggest issue is trying to figure out financing with the looming $18K bankruptcy payment. The father does not have any funds to loan to us so really all this comes down to is how we are going to come up with the $18K and then how we will pay that off. Just trying to think of a creative way to do that since that is the first thing that has to be paid before anything else.

How to finance the first rental property

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