Sell house to family member?

Question

Hello, I am relatively new to investing and was just hoping to get some feedback on experiences from other investors.

My question is this.  I bought a house in cash in Phoenix for 60k the comps in the area are about 70k.  I put my name and my moms name on the deed (which may or may not have been a good idea?)

The thing is that now I want to sell this house because I have some expenses that came up.  It is rented for about $800 a month.  My mom is interested in the house as she helped with renovation etc. and thinks its a nice property.

She has access to credit and would like to buy the house from me.   Do banks frown upon this type of transaction?

I would think that they would just run the comps or do an appraisel to find the value and maybe my mom could buy it off me for around 70k?  (as long as that is the true value)

Do banks treat these type of loan applications any differently from others?
Do they limit the amount of loans between family members?

Thank you for any knowledge.

Sincerely,

John

Jon Holdman · Answer

Since she already owns the house, she would refinance, not purchase.  She would do a cash out refi in her name only.  She would use the proceeds to buy you out.  You would then deed yourself off the property.  Could just be a quit claim from you to her.  Cleaner for the title if you do a warranty deed with "you and her" as the grantor and her as the grantee.

If you've owned this for more than a year, the bank will probably just do a new appraisal to determine the value.  Since its a investor loan, they probably won't go more than 70-75% LTV.  There will be some costs, too, and you'll have to prepay insurance and tax escrows.  So, she may not be able to get a big enough loan to fully cash you out.

If you're only owned it a few months the bank will probably use the price you paid as the value.  You may be able to convince them to include any documented rehab costs.

Jon Holdman · Answer

I still see no upside to her deeding her interest to you then selling it to her.  Assuming she buys for $70K and the bank will do a 75% LTV, she would get a loan of $52,500 and put in a down payment of $17,500.  She would have a few grand in closing cost and prepaids and you would probably have a grand or so in closing costs plus the costs for her to deed it to you.

If she just does a cash out refi and waits until April, and the house does appraise for $80K, then she could get back about $60K.  She would have to come up with a few grand in costs and prepaids and would own you another $10K.  At the same time, you would deed the house fully to you.

If you speak with a title company (or 2 or 3) and explain what you want to do, they should be able to work up more specific costs.

I'm just missing how its helpful to do the extra transaction of you+her to you.

The strategy of pulling equity out of a house is very, very difficult.  Banks are only going 75% for SFR investments.  Maybe you can find a liberal one that will go 80%.  If you get to the point of owning more than four, it drops down to 70%.  Values are not rising very fast, if at all.  So, you buy something now with a 75% loan.  A few years out you want to pull out equity.  Say the value has risen from $80K to $90K, which I think is absolutely on the high end in many places.  You have an existing $60K loan.  You can refi for 75% of $90K, which is $62,500.  That $2,500 difference is going to be largely eaten up by the cost of the refi.

The bank views "equity" differently than you.  You say I own $60K on a house that's worth $80K so I have $20K in "trapped equity".  If you sell, though, $8K or a little more will get spent on the selling costs.  If the bank has to foreclose, their legal costs can easily be $10K, and they still have some of the same costs as you.  So, maybe they net $62-65K after the foreclosure sale.  Trouble is, at a foreclosure sale, the house won't bring $80K.  Thats the price when nice.  If it goes to foreclosure, you probably won't leave it in the best condition, and its going to set empty for a while.  Stuff happens.  So, maybe they actually sell for $70K and net $55K after the sale.  So they see that $20K of "trapped equity" as their buffer that minimizes their loss if they take the house.

The problem is your deal is not very good.  You paid $70K for the house.  You did some work on it, which I'm sure was not free.  Now its worth $80K.  You essentially paid retail.  If prices were rising quickly, as in the boom, you could generate some real equity over the course of a few years.  That's not the case.  So, you have to find better deals doing in.  I'd like to be all-in - purchase plus rehab - at around 70% of its current value.  So, if its worth $80K fixed up, and needs $5K in fixup (i.e. "lipstick only"), I would want to pay less than about $50K.  To follow your process, you pay $50K, spend another $5K to fix it up, and a year later, it can appraise at $80K.  You get a 75% LTV loan of $60K, subtract $2000 for closing costs and you have $58K or so in hand.

Its tough to find deals like that.  And you need a friendly lender to do that loan. And you need good credit, 660+ to start, 720+ as you accumulate more properties, good income, and some cash in the bank to cover reserves.

Nathan Emmert · Answer

I think you're confusing things.  Lets separate "loans" and "mortgages".

I'm going to assume she's "approved" for an $80k mortgage, not a loan.  As such, that $80k will be applied directly towards 1 transaction.  If she would, for example, buy a $40k home, she would not get $40k additional in cash, she would simply get a $40k mortgage instead of an $80k mortgage.

You don't really tell us her financing situation.  Assuming she has access to some cash, she can leverage that at a 3:1 ratio.  Every $100k in cash she has can generate about $300k in borrowing allowing her to purchase about $400k in real estate.  There are some DTI guidelines she'd have to meet and there's a limit of 10 mortgages that could come up as well but in generally that's how it works.

As far as leveraging properties, banks get a little touchy on this.  They don't like to acknowledge that you "bought" equity by finding deals below FMV.  As Jon mentioned, generally any refi within a year will be based on the purchase price, they won't even do an appraisal to see if the home is potentially worth more, some banks go as far as making you wait 2 years.

But "in theory", you could say buy a $250,000 house for $200,000.  You would put down 25% of $200,000 and mortgage the other $150,000.  Assuming you could find a bank that would allow it, you could then refinance to 75% of $250,000 and get $37,500 of your money back out of the house and use that to buy a 2nd house at $150,000 (again 75% LTV).  If that house were worth $200,000, you could refi out your $37,500 and do it again... and again... and again...  Now there are closing costs and other things I'm glossing over, but that's the gist of it.

Leverage is still around though not to the same extent.  You can't use property or equity in property directly, they want the cash not a deed.  You can still leverage but no longer to 100% (or higher) LTV, now most are 70 - 75% LTV.  Banks are far more conservative with valuations and appraisals.  But if you learn the system, it still beats the pants off buying in cash.

John Woods · Answer

Thank you Jon.  The reason we were hoping to do it this way is because I would like to take my money out of the deal for other uses.  My mom however, is interested in investing more.  She is prequalified for a loan amount of 80k. (she is in the market for an investment property right now) She wanted to buy the house off me- lets say for 70k and then in a year or two pull out some equity from that to purchase ANOTHER home.  Do you know if that is even possible (for her to ultimately buy 2 houses with one 80k loan and two down payments- lets say 40k?) as you mentioned it may be difficult to find a lender.  How do investors use leverage like that or is that a thing of the past?

Jon Holdman · Answer

So, a lender is likely to use the price you paid, perhaps plus the documented rehab expenses, as the "value" for a loan.  I don't see much point in changing the deed from you and her to just you, then selling it to her.  That's two transactions that will incur more costs.  The sale from you to her will be a real sale.  Meaning the lender is going to determine the value as the lower of the transaction price, an appraisal, and, maybe, the original price you paid.

She should see if she can just refi it in her name.  This is not all that unusual, even though you're on the title.  It might be done in any case where joint tenants on a title want to switch to just one of them owning it.  I don't understand why you want to take the extra step.

Have you tried talking to a lender (or 10, it can be tough to find someone who will do investor loans)?

John Woods · Answer

Sorry, April 2011- it's not 2012 yet.  So about nine months.

John Woods · Answer

Hi Jon we purchased the house April of last year.

Jon Holdman · Answer

How long have you owned it?

John Woods · Answer

Hi Jon and Cheryl thank you for your replies.
I thought that since the house was in both our names she could simply deed the house over to me since she put no money into it and then I could sell it to her.
  Do you know why a bank would care what we do as long as the house appraised at the value that the loan would be for?
It wouldn't surprise me if they didn't allow it as I am sure they have many rules, its just too bad that they don't allow people more freedom to maneuver.

Cheryl C. · Answer

Jon, you beat me to the punch.

Sell house to family member?

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