Building an ADU/ House Hack, When You Have Poor Credit/Low Income

[Gregory Serrano]

My friend Ted will receive a house as his uncle is passing away soon. The house is in North Hollywood Los Angeles County with a $525k reverse mortgage, property valued at $950k. Ted has poor income and 670 FICO and will most like not be able to Refi/pay back the reverse mortgage after his uncle passes. If he sells the house he will pay capital gains taxes and squander an opportunity. It would also be good if he could stay in one of the rooms rent free. Can he partner with a real estate investor, pay back the $525k reverse, then accept an interest only carry back for the equity of $425k? Then the investor can convert the garage to an ADU, and rent the other three rooms out allowing Ted to live on site as management. What is the best way to structure this deal so that:

1. Ted has a place to live 

2. Ted doesn't get hit with capital gains 

3. The reverse mortgage gets paid 

4. The investor is able to build an ADU and create a cash flowing property for everyone to enjoy with less money down

5. Ted can benefit in a small percentage of the appreciated value

What is the best way to structure this deal as a win-win?

[Rick Albert]

Why not look into the FHA 203(k) loan? Minimum 580 credit score and allowed to have a high DTI. He could pay off the reverse mortgage and be given money to build the ADU.

The goal would be to keep the mortgage as low as possible to increase cash flow. Rent out the ADU for probably $1,600+/month for a studio and each room in the $900-$1,000/month range.

[Matt Devincenzo]

First there is a fatal flaw in the reasoning for this in the assumption that there will be capital gain. There is a step up in basis at death meaning that the full value at date of death could be achieved with no taxes owed. So the first question(s) is does that apply here to his inheritance and does that change the perspective on what the right approach to this might be? 

Second is I'm sure you could probably find an investor for something like this if he were to owner carry a second etc. But I think there would need to be a bit more give on his either receiving a discounted total payment or he needs to move/pay some rent going forward. Those details of course could be worked out later, I'm just saying that would be a component he needs to acknowledge there is some flexibility likely needed to reach a deal. 

[Caroline Gerardo]

Several moving parts. Reverse gave heirs 12 month time frame from his death to refinance or sell. If that deadline is approaching he probably needs help extending with a plan in place. 

Is there probate? Who are the other heirs? Has he filed with the courts? What other assets or liabilities exist?

His FICO is fine. Income may or may not work. Would need to know his actual income but should be around $10000 a month to make a $540000 loan amount with tax and insurance - this is only a guess as you gave no numbers. I increased the loan amount as balance and fees unknown.

What is his health/ commitment to the community location/ ability with money/ age? Can he manage tenants? Without experience I would say he

he a target for trouble.

Sounds like your worry is he might end up with a conservatorship which is not what I would choose for family.

Maybe take the $400000 and buy for cash in lower cost location or with trusted family member? I say 400000 as there are expenses to sell and no idea what shape the property is today. Maybe buy in Central Valley a SFR that is in good condition and he can pay the tax and insurance easily from his income???? Then rent a room for a little help?

[Gregory Serrano]

Quote from @Rick Albert:

Why not look into the FHA 203(k) loan? Minimum 580 credit score and allowed to have a high DTI. He could pay off the reverse mortgage and be given money to build the ADU.

The goal would be to keep the mortgage as low as possible to increase cash flow. Rent out the ADU for probably $1,600+/month for a studio and each room in the $900-$1,000/month range.

Ted's income would not be able to carry (on his own) enough money to pay off the $525k reverse mortgage, and build an ADU. I think he might need to pull another investor experienced in CA rental investing/ ADU's. He is willing to accept/ carry back a second for his equity. Maybe he can carry back a 10 year balloon of his equity in exchange for a place to live. Or he could offer partial ownership of the property in exchange for a place to live and a portion of all rents collected.

[Gregory Serrano]

Quote from @Matt Devincenzo:

First there is a fatal flaw in the reasoning for this in the assumption that there will be capital gain. There is a step up in basis at death meaning that the full value at date of death could be achieved with no taxes owed. So the first question(s) is does that apply here to his inheritance and does that change the perspective on what the right approach to this might be? 

Second is I'm sure you could probably find an investor for something like this if he were to owner carry a second etc. But I think there would need to be a bit more give on his either receiving a discounted total payment or he needs to move/pay some rent going forward. Those details of course could be worked out later, I'm just saying that would be a component he needs to acknowledge there is some flexibility likely needed to reach a deal. 

Thank you for mentioning this. The house in in a living trust and Ted is the executor of the trust. So my assumption is there will be no capital gains owed? Ted would be willing to carry back a second mortgage and would be willing to offer more equity in exchange for a place to stay. The reverse mortgage needs to be paid off in 6 months after death but you cannot do a cash out mortgage to build an ADU until six months after being added to title. If you were in Ted's situation, how would you structure this offer to an investor?

[Gregory Serrano]

Quote from @Caroline Gerardo:

Several moving parts. Reverse gave heirs 12 month time frame from his death to refinance or sell. If that deadline is approaching he probably needs help extending with a plan in place. 

Is there probate? Who are the other heirs? Has he filed with the courts? What other assets or liabilities exist?

His FICO is fine. Income may or may not work. Would need to know his actual income but should be around $10000 a month to make a $540000 loan amount with tax and insurance - this is only a guess as you gave no numbers. I increased the loan amount as balance and fees unknown.

What is his health/ commitment to the community location/ ability with money/ age? Can he manage tenants? Without experience I would say he

he a target for trouble.

Sounds like your worry is he might end up with a conservatorship which is not what I would choose for family.

Maybe take the $400000 and buy for cash in lower cost location or with trusted family member? I say 400000 as there are expenses to sell and no idea what shape the property is today. Maybe buy in Central Valley a SFR that is in good condition and he can pay the tax and insurance easily from his income???? Then rent a room for a little help?

 The uncle is still alive but is passing away soon. Ted is the executor of the living trust and will be awarded the house and all the contents. Ted has to pay off the reverse in six months after his uncle's death, but can extend it to 12. Ted has income around $5,000 a month so he feels he would need to pull in an investor to get this done right. He has no experience managing tenants and in California that could be dangerous. I really want to see Ted win for once in his 56 years. Since this is a Los Angeles county property I feel that this could be turned into a $1.3M property with the right investor/construction and property management. Knowing what you know now, how would you structure this deal? How much equity would you offer to an investor?

[Caroline Gerardo]

Ted's income is not enough to refinance the HECM. I feel an investor will rip him off and he won't know what hit him on the back side of the head. He cannot offer an investor ANYTHING until AFTER the title is transferred to his name: as in uncle dies and he pays off the HECM. 

Clean up, paint neutral, sell in the 45 days after uncle passes. Sell all the contents. First: Items of value on etsy and auction. After valuables are sold have two garage sale weekends. Put most of the contents on driveway. Get rid of everything. Then clean the house four times top to bottom and paint interior off white. List with Realtor for 2% at moderate price and get it done. Find replacement SFR in lower cost area or put funds in a Trust until he retires. Do not allow someone to charge management fees for the Trust. Having a house free and clear or with $100000 loan will free him up to live without worry.