Is Creative Financing Becoming the New Subprime Lending?

Is Creative Financing Becoming the New Subprime Lending?

Realtor · Boulder, CO · Member since 2016 · 3k+ posts · 5k+ votes

Rising interest rates have hurt everyone’s buying power (except cash buyers obviously), and inventory is locked up because nobody wants to move and give up their historically-low interest rate. Word on the street is we’ll never see those rates again in our lifetime.

Having alternative strategies in your back pocket can be very helpful in putting deals together. That’s why more people are looking into different options such as seller-finance, subject to, wraps, lease options, etc. “Creative Financing” 

However, not many people are talking about the additional risks.

For example, with seller-financing: the worst case scenario is a buyer doesn’t make payments. No problem, seller has the promissory note and just takes the property back. Great, except “taking the property back” means foreclosing . Foreclosing sucks. It takes a long time and costs a lot of time and money. Plus, usually no payments are coming in during that time, the tenant(s) may need to be evicted, the property usually sits vacant and comes back in worse condition. Someone still has to cover taxes, insurance, and upkeep during the foreclosure.

Subject to is a similar half-truth: “If the bank exercises their right to enforce the due on sale clause, just deed the property back to the seller and use an executory contract: contract for deed, lease option, land contract instead.” But the bank usually still exercises their right to enforce the DOSC because title changing hands meets the bank definition of a sale. Also, each time you transfer the deed the IRS wants their cut. Not to mention closing costs. Not to mention that executory contracts don’t have the same benefits that sub to does because in a C4D the buyer does not have title and seller can easily cloud title or the seller can get a judgment against them or lien that attaches to the property. This can also cause issues with both title insurance and homeowner’s/landlord insurance. 

Every strategy has its appropriate time and place. But any sellers looking to "become the bank" should be vetting buyers like any other lender would. It doesn't seem like many are as creative financing becomes more mainstream.

$0 down deal structures with "infinite returns" are du jour. People are doing deals and capturing zero equity or cashflow, just to get properties with low interest rates, which is what we used to call being “over-leveraged". 

Too many owners being over-leveraged is what lead to massive foreclosures in the last big downturn 2008-2010.

Many buyers looking to use creative finance wouldn't make it through underwriting, which makes them sub-prime borrowers.

Is Creative Financing Becoming the New Subprime Lending?

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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
2y

in my experience over the decades were I have done quite a few owner carry and quite a few sub to.

And we were doing wraps back in the carter years when rates were double what they are today.

So lots of experience both good and bad.

from my point of view seller carry back IE seller owns the property free and clear and wish's to owner finance.. this can be pretty safe in some states high risk in others.. whats the difference the difference is foreclosure time lines. @Rick Pozos  AS Rick noted he has not had issue when had to foreclose but he is also in Texas VERY short time lines..But you do the same transaction in Mortgage states were forclosures are judicial and time lines are years.. NY being one that can be really bad. So to me on that front its state specific and mortgage compared to deed of trust Trustee sales.

On Sub to the risk falls almost exclusively on the Seller.. And what this does is open up a lot of transactions for undercapitalized investor who talk a great game and sellers are not experinced or do not consult attorney or Broker to the risks.. And the next thing they know the smooth talking guy / gal who took the course .. Has no real money and realizes hey the mortgage is not in my name and well there is no equity so I cant sell it I would have to come out of pocket and well I think I will just stop paying and collect Rents until the bank forecloses thereby trashing the orignal sellers credit and basically ruining their life.. those are the deals I have personally seen and that is why I am very much opposed to Sub too as a long term investment by Most investors who simply dont have the capacity to carry a deal if the tenant stops paying etc.. or is Bent and believe me there are tons of Bent folks out there that will think nothing of screwing nice people.   And I dont care who teachs this Morby  the sub to guys on Bp  myself anyone this is a huge risk to sellers.

Then you have owners who have debt and want to wrap the loan and sell and make the delta I like this the best as they will stay in the game  they have control of the underlying debt and they have a document ( all inclusive Deed of Trust) that they can foreclose out the owner finance buyer.

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  • Realtor · Boulder, CO · Member since 2016 · 3k+ posts · 5k+ votes
    2y
    Quote from @David M.:

    @Steve K.
    So, in reality I don't see seller financing helping the seller sometimes, in the grand scheme --- but it maybe the best they know how to move forward.  Meanwhile, it entirely benefits the buyer while pitching how much its helping out the seller.... (sigh)

    In the case of subto especially there are many risks for the seller that usually outweigh the benefits by a lot: such as messing up their DTI ratio, may not qualify to get another loan, and in worst case scenarios if the buyer rips the rents and doesn't pay the mortgage: wrecking their credit, forcing them to sue the buyer or foreclose on the buyer, and effecting their ability to even rent a home in the next 7 years. Not often disclosed by prospective subto buyers I'm sure.  
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    2y
    Quote from @Steve K.:
    Quote from @David M.:

    @Steve K.
    So, in reality I don't see seller financing helping the seller sometimes, in the grand scheme --- but it maybe the best they know how to move forward.  Meanwhile, it entirely benefits the buyer while pitching how much its helping out the seller.... (sigh)

    In the case of subto especially there are many risks for the seller that usually outweigh the benefits by a lot: such as messing up their DTI ratio, may not qualify to get another loan, and in worst case scenarios if the buyer rips the rents and doesn't pay the mortgage: wrecking their credit, forcing them to sue the buyer or foreclose on the buyer, and effecting their ability to even rent a home in the next 7 years. Not often disclosed by prospective subto buyers I'm sure.  

    Keep in mind Steve on a straight sub to .. title has transferred there is no security instrument in favor of the original seller that allows them to foreclose.. there can be an agreement to deed it back etc.. but Bent individuals dont also do what they agree to do. So sellers only recourse at that point is full blown litigation all the while the Bent individual is ripping rent  trashing the house etc etc. Of course not everyone is bad and many ( like my company) can execute but we used Sub to for short term and we NEVER bought without substantial equity day one.  These folks that think they are going to build long term buy and hold are the ones that can run into lots of trouble.  So for a seller is it worth it. Generally I would say no. And frankly if sellers sat with a decent RE attorney very few would ever agree to a straight sub to without additional fore closable collateral.
  • Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes
    2y
    Quote from @Jay Hinrichs:
    Quote from @Steve K.:
    Quote from @David M.:

    @Steve K.
    So, in reality I don't see seller financing helping the seller sometimes, in the grand scheme --- but it maybe the best they know how to move forward.  Meanwhile, it entirely benefits the buyer while pitching how much its helping out the seller.... (sigh)

    In the case of subto especially there are many risks for the seller that usually outweigh the benefits by a lot: such as messing up their DTI ratio, may not qualify to get another loan, and in worst case scenarios if the buyer rips the rents and doesn't pay the mortgage: wrecking their credit, forcing them to sue the buyer or foreclose on the buyer, and effecting their ability to even rent a home in the next 7 years. Not often disclosed by prospective subto buyers I'm sure.  

    Keep in mind Steve on a straight sub to .. title has transferred there is no security instrument in favor of the original seller that allows them to foreclose.. there can be an agreement to deed it back etc.. but Bent individuals dont also do what they agree to do. So sellers only recourse at that point is full blown litigation all the while the Bent individual is ripping rent  trashing the house etc etc. Of course not everyone is bad and many ( like my company) can execute but we used Sub to for short term and we NEVER bought without substantial equity day one.  These folks that think they are going to build long term buy and hold are the ones that can run into lots of trouble.  So for a seller is it worth it. Generally I would say no. And frankly if sellers sat with a decent RE attorney very few would ever agree to a straight sub to without additional fore closable collateral.

  • Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes
    2y

    As far as standard land sales contracts or notes and trust deeds a vanilla 20% down solid buyer nothing creative there. There are those sellers that have lots of cash and more just a burden would prefer it to remain in a property they know. If deal goes south they are not hurt. 

    The word creative makes me cringe. New buyers who figure they can suck cash flow out of a property to live on creating a house of cards is a potential Ponzi and if unsuspecting and unsophisticated sellers are involved and a little fraud happens then where is the line? Have watched people grow too fast overleveraging just to see it all blow up. Lots of people hurt and some angry attorneys one can actually get in trouble.

    How about working 2 or 3 jobs? How about becoming really useful in the industry where a person with some serious wealth can help you get started. Have a job and get that first FHA fixer loan nothing creative there. I understand the sales aspect of it all but have a heart too.

  • Member since 2019 · 7k+ posts · 4k+ votes
    2y
    Quote from @Chris Seveney:

    @Steve K.

    100% agree which is why I am against people doing seller financing

    They are investing in a security instrument that is typically over leveraged because they may sell a $200k home for $220k, and get 7-8% taxed at ordinary income

    I can invest in other investments and get 8-10% taxed as qualified dividends or get depreciation and have ltv’s below 70%… throw in these borrowers are typically not underwritten properly and have a high chance of failure and I scratch my head why people think this is a great idea

    I think a lot will learn the hard way in the next 2-3 years


     I really like you and Steve when saying this so I don't have time to spend time thinking about it.

    From beginning I think the risk is too high for this seller financing stuffs, it just doesn't make sense in long run.

  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    2y
    Quote from @Carlos Ptriawan:
    Quote from @Chris Seveney:

    @Steve K.

    100% agree which is why I am against people doing seller financing

    They are investing in a security instrument that is typically over leveraged because they may sell a $200k home for $220k, and get 7-8% taxed at ordinary income

    I can invest in other investments and get 8-10% taxed as qualified dividends or get depreciation and have ltv’s below 70%… throw in these borrowers are typically not underwritten properly and have a high chance of failure and I scratch my head why people think this is a great idea

    I think a lot will learn the hard way in the next 2-3 years


     I really like you and Steve when saying this so I don't have time to spend time thinking about it.

    From beginning I think the risk is too high for this seller financing stuffs, it just doesn't make sense in long run.


    There is a time and place for it - for example I have a property that will not get conventional financing because it needs a rehab - yes I will seller carry that but for 12 months. Writing loans for 30 years etc. with high LTV and poor borrower credit, which it seems like a lot of those deals are - is a recipe for disaster.

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  • Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    2y

    @Steve K.

    https://www.biggerpockets.com/forums/311/topics/1181525-spre...

    Doesn't anybody realize that this thread basically shows how the seller gets shafted?  Yeah, its supposed to show how "great" a sub-to deal is for the buyer.  But, the start of this deal is comparing how the deal work so to convince the seller into a $332k price instead of $400k...  Yeah, investors have no fiduciary duty...

    And they say Realtors suck when they are still trying to get the highest and best for their clients...

  • Member since 2019 · 7k+ posts · 4k+ votes
    2y
    Quote from @David M.:

    @Steve K.

    https://www.biggerpockets.com/forums/311/topics/1181525-spre...

    Doesn't anybody realize that this thread basically shows how the seller gets shafted?  Yeah, its supposed to show how "great" a sub-to deal is for the buyer.  But, the start of this deal is comparing how the deal work so to convince the seller into a $332k price instead of $400k...  Yeah, investors have no fiduciary duty...

    And they say Realtors suck when they are still trying to get the highest and best for their clients...


     I was about to say this thread was a discussion to counter Ken. M. arguments in another thread. 

    But my own thinking is the risk is unlimited here with only very few advantage. I don't know the practicality of these approach.

  • Andrew SyriosPro Member
    Moderator
    Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes
    2y
    Quote from @Steve K.:
    Quote from @Andrew Syrios:

    I don't think so. Creative financing usually becomes popular when either 1) interest rates rise or 2) the credit market freezes.

    So seller financing became really popular in the 70s and early 80s because interest rates had skyrocketed. And subject to became really popular after the 2008 crash because it was almost impossible to get a loan.

    Neither of these things have teaser rates and usually (although definitely not always) the (mostly) investors getting creative financing aren't in terrible financial shape. Also, the amount of creative financing going on pales in comparison to the amount of subprime lending pre-2008. I really don't think there's much of a comparison. 


     I hear you, especially on that last point. I guess my question is more of a hypothetical if it gets to be more mainstream, since it’s become such a hot talking point for coaches, mentors, gurus, writers etc. I hear agents talking about it who don’t work with investors and have more retail-type buyers and sellers asking about it, so it seems to be becoming more mainstream. 

    Hypothetically it's possible, but I sincerely doubt it will ever get that far unless interest rates really skyrocket like they did in the 70s and 80s. Gurus and the like can only have so much influence (thankfully)

  • Andrew SyriosPro Member
    Moderator
    Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes
    2y
    Quote from @Jay Hinrichs:
    Quote from @Andrew Syrios:

    I don't think so. Creative financing usually becomes popular when either 1) interest rates rise or 2) the credit market freezes.

    So seller financing became really popular in the 70s and early 80s because interest rates had skyrocketed. And subject to became really popular after the 2008 crash because it was almost impossible to get a loan.

    Neither of these things have teaser rates and usually (although definitely not always) the (mostly) investors getting creative financing aren't in terrible financial shape. Also, the amount of creative financing going on pales in comparison to the amount of subprime lending pre-2008. I really don't think there's much of a comparison. 


    one usually gets premium pricing and premium interest rate. 
    That's true, but (I think usually) the seller financing is for investment purposes and (again usually) the investor (at least mostly) knows what their doing. So I don't see any big collapse in seller financed deals. Nor are there enough of them to bring down the economy like subprime in 2008. 
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