Real Estate Investor · Topeka, KS · Member since 2010 · 63 posts · 40 votes
Hi,
even though I really didn't want to, in the end I had to accept a condition of the seller to have adjustable rate on the seller's financing. There is a 4 year balloon, so I just hope that the interest rates won't skyrocket now.
Do you have experience with having seller's financing with ARM? Is it so unusual?
And one curious questions, do you think that the inflation will run high and therefore the interest rates will skyrocket in the next couple of years? Just wondering what people here expect.
Private Financing Consultant · Honolulu, HI · Member since 2010 · 132 posts · 27 votes
15y
John,
Have you have a chance to review your seller's promissory note to her bank? Residential properties more than 4 units are usually considered as commercial property and commercial loans are usually set to balloon in 3, 5 or 7 years even if they are amortized for 15 to 30 years. Many commercial loans are defaulting now because those loans are ballooning and the borrowers could not refinance because of their credit, property value, and other factors that prevent them from getting a new loan.
Your concerns to the property should include the interest rate, cash flow, value, time that you have to pay off the seller, and your personal credit. There should be enough cash flow from the property that you can use the income to pay your monthly payments, and to set aside a reasonable amount so that in the 2 year period that your bank requires the documented income you can save up at least 25-30% down payment plus conventional closing cost. You should make effort to purchase the property with a new loan so that you could have better control of the deal.
Full-Time Investor · Charlotte, NC · Member since 2009 · 2k+ posts · 1k+ votes
15y
this is not unusual..the most important thing to address now is how the new interest rate will be decided on...if you're buying, i'd request a cap that the interest rate can not exceed..if you're the seller, i'd put in something along the lines of "it will adjust to __ points above prime...youcan fill in the blank...and yes, i do expect interest rates to go up in the next decade....we are printing a ton of money, and in my opinion, interset rates are so low that they can only go up from here
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
15y
Is this some sort of commercial deal where variable rates are the norm? If this is a SFR or some other type of property where fixed rates are possible, I'd start doing whatever it takes to refi and pay this seller off. I won't make a prediction but I would point out that rates are EXTREMELY low right now. If its possible to lock in a fixed rate it would be foolish not to.
Real Estate Investor · Topeka, KS · Member since 2010 · 63 posts · 40 votes
15y
Bryan, the rate is adjusting at the same rate as the seller's underlying loan rate is. That's why she wanted ARM, so she would be sure that my payments will cover hers in the future. In a case it wouldn't, I am not sure if she would keep paying off her loan, and I would be in a risk that her bank would try to take the property.
Therefore I didn't even try having any cap on the interest rate.
Jon, it is 5-unit multi family property. In the bank they told me that I have to wait at least 2 years to get enough of operation and income data - to be able to refinance. But I will be trying it maybe even sooner. It is true that even though paying 1 or 2 years 2 % extra won't ruin my investment, paying this 2% extra for next 20 years (if I would refinance) - will make it quite substantially worse though.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
It is perfectly reasonable for the seller to want an ARM if you are wrapping around an ARM. ARMs aren't always bad if you can get a small bump above some stable index for the fully-indexed rate. An added benefit is that the payments decrease when the loan adjusts if you prepay the mortgage to maintain the same amortization period. Consequently, you can use some of the cash flow from the project to prepay the mortgage if you can't get the exact financing you want so that your payments will adjust south as time goes on.
Rates are almost certain to rise because they are ridiculously low. This really doesn't matter...what matters is if you have sufficient margin in your worst-case rate to still have positive operating leverage.
Centennial, CO · Member since 2010 · 5 posts · 0 votes
15y
I would pay attention to Mr Holdman and Hanncock in this thought process, but keep in mind the fact is you have no cap and yes things are not getting any better and rates will go up. My opinion is that with the amount of money our Fed. is printing and nothing to back it up rates could easily triple in the next decade.
Real Estate Investor · Topeka, KS · Member since 2010 · 63 posts · 40 votes
15y
I will post the exact terms later, if you guys are interested. However I am waiting for the seller to finally sign the contract today (the thanksgiving last week slowed the process down), and therefore I don't want to talk here about all the details.
Anyway, I should have quite high margin of safety, even if the interest rates would double in 3 years. If there would be hyperinflation, then I am screwed, but I think I wouldn't be the only one. ;o)
And Bryan, I did contact her bank and asked about the cap. Here is the funny answer from them:
"Her cap on the interest rate is 36%, but do not worry, the interest rates in last 40 years didn't get over 12%."
I was laughing, when the bank was so assuring me about not getting over 12%, but still having made her cap on 36%. :D
Full-Time Investor · Charlotte, NC · Member since 2009 · 2k+ posts · 1k+ votes
15y
even if her amount is allowed to go way up to 36%, i would think/hope there is a cap on how much it can increase each year, or whenever it resets...is this the case? if so, joon is right--the sooner you can get this refinanced the better...that being said, are you interested in this deal bc of the numbers or the owner financing? if the owner owes too much, and that is why she's financing, you're not going to be able to refi in a few years..the property will need to appraise
Private Financing Consultant · Honolulu, HI · Member since 2010 · 132 posts · 27 votes
15y
John,
Have you have a chance to review your seller's promissory note to her bank? Residential properties more than 4 units are usually considered as commercial property and commercial loans are usually set to balloon in 3, 5 or 7 years even if they are amortized for 15 to 30 years. Many commercial loans are defaulting now because those loans are ballooning and the borrowers could not refinance because of their credit, property value, and other factors that prevent them from getting a new loan.
Your concerns to the property should include the interest rate, cash flow, value, time that you have to pay off the seller, and your personal credit. There should be enough cash flow from the property that you can use the income to pay your monthly payments, and to set aside a reasonable amount so that in the 2 year period that your bank requires the documented income you can save up at least 25-30% down payment plus conventional closing cost. You should make effort to purchase the property with a new loan so that you could have better control of the deal.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
36%?! Surely that is against the usury laws! I am guessing that there is other language in addition to this language that hedges for usury laws.
Others bring up good points...you want to make sure you aren't up against a hard balloon with the seller's financing. I would want to see the loan docs before I was locked into a contract with hard earnest money!
Real Estate Investor · Topeka, KS · Member since 2010 · 63 posts · 40 votes
15y
Hi everybody,
I have been on a short vacation, but was able to close the deal right before that. It was pretty rushed, we signed the contract just 1 day before the closing date (which I had in the beginning of the month, for the pro rated rent purpose).
Just to give you more info about this deal, if you are still interested.
I have reviewed the underlying loan of the seller and here are the details:
15 year (no balloon), ARM (adjusted annually, 2.5% above the commerce bank index, min. 6% and max 36%).
I agreed in fact to adjust my interest rate (on the seller's financing) in the same way as the sellers will have on hers. This way, I will always be able to cover seller's payment with my payment. It's not the best, but the whole deal seems to give me quite high safety margin.
I have bought the whole property for only $55K with $12K down, the loan payments start around $500 and I am covering now the utilities (will have to be separated for each units next year).
I will invest another $10K for repairs in next few months.
The great part though is that with just 4 unit rented, the gross scheduled income is $2100 per month and with the last unit rented will be probably $2700.
So the returns sound almost incredible. I can post here some IRR or cash-on-cash results if you want to see.
Real Estate Investor · Topeka, KS · Member since 2010 · 63 posts · 40 votes
15y
Originally posted by Bryan Hancock:
I would like to see the IRR and such.
Does the note amortize over 15 years?
Hi Bryan,
so I have done 2 analysis reports:
#1 - using actual expenses I got from the previous owner and some estimates.
In this case the IRR seems to be: 35.45 % Here is the report with the rest of the ratios and
details .
#2 - using the 50% rule for the expenses.
In this case the IRR was: 24.80 % And here is the whole
report .
Just a few details - I have paid $12,000 down payment, but I am going to spend approx $10,000 in renovating 5th unit and for some other repairs. In the analysis, I had to put it in the "loan coast", because I don't have there "rehab costs" feature yet.
Also I have balloon in 4 year and the note is amortizing over 9 years (to reach the same height of the monthly payment as the seller pays). After that I was estimating to refinance @ 5% interest, 20 year amortization.
Again, this is something my analysis tool can't do yet - so I had to simulate this with 2 loans (one for 5 years and one for 25). I have to get again to programming, to add these features. ;o)
What do you think about the investment? I bet it's really small for you. But it seems to have good IRR (even when using property management).
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Nice reports...I don't have time to study them right now, but if your numbers are close it looks like a great investment!
I am glad to see the 50% emperor truly has not clothes!
Estimating the financing post balloon is extremely risk IMO and could blow the whole analysis. If you don't have a prepay I would highly recommend trying to refinance asap while rates are still low!
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Not to rain on your parade but seller financed ARMs are now regulated. The index shall be the ten year T Bill, margin no more than 2 1/2% as I recall, floor is entry rate and ceiling I don't recall. A wrap is not to be over 2% of the underlying obligation. The loan must be fully amortized and any balloon payment required is restricted based on the amount of principal reduction by the amortized payments. The loans may not have a pre-payment penalty.
The pre-payment has been a popular covenant to pay the tax liability that becomes due arising from an early payoff. A legitimate issue, but no longer.
These restrictions are listed in the HUD guidelines for originated and are enforced by the appropriate regulators to the originator. They may veary state by state as may be approved by that regualtory agency overseeing those loans.
At issue too is that there is a difference between money loans and equity loans. What is usually missed here, IMO, is that many investors financing deals may try apply cash loan rules to equity loans. They are different as the equity loan is considered an installment sale, regardless of title being transferred as with a note and deed of trust vs a contract for deed....it's irrelevant.
Bonafide commercial deals are exempt. Remember too, that it is the secured property that defines the type of loan, being commercial or residential, not the fact that you have a business enterprise or that the property will be owned by a business entity. Check you state laws and your attorney.
Since the SAFE Act is in effect John, I suggest you check with the Kansas Department of Finance, RE Division and run your note by them before you do your deal.
Good luck.
Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
15y
Originally posted by Bryan Hancock:
Do you have a link for this Bill? A statute? I would like to learn more about it...must be new.
Bryan, off the top of my head, it's contained in the preditory lending law, referenced in the SAFE Act and also referenced in the CFPA.
The difficulty, IMO, is looking to the intent of the law, any law, while it is stated at the beginning of each law ( and breezed over by most readers, IMO) you can see how inter-twined legislation becomes. The SAFE Act has caused several old statutes to be amended, including the TIL, which discloses how ARMS will be disclosed.
Also, I didn't mention, that an ARM will need to be disclosed by it's estimated APR, and following that requirement leads you to the requirement that the APR is to be computed within one tenth of one per cent for the required term. First of all, while there are computer programs available to do this, not all are correct to this extent. As to calculators, to my knowledge, the are only two, the Texas Instruments BA II and the Hewlett Packard 12C (I think it is). So doing any ARM will need to be disclosed within this tolorence and frankly, most seller won't be able to comply with the math required!
Bryan, nothing is simple in financial regulations. And everything is regulated in finance, especially now. Hope that helps your research.