Interesting.....Owner finance or Lease Option??

Question

I would really appreciate some expert insight on how to structure this new offer on my townhouse....

They buyers really want to buy it.  I told them the price of $377k.  I owe $376k.  It is worth about $250k with all the foreclosures and REO's in the area.

They have kind of poor credit but their business is ROCKING....They bought a Subway franchise.

They can put up to $15k down......

I currently have a pay option ARM.  And I am thinking of asking for a modification on it to get them to fix it for a nice low rate.

My monthly payments are around $2500/mo depending on the variable rate at the time.....

Can you offer a few different ideas on how to structure this so they can move in and I can stop stressing over it?

I was thinking of having three different options for them, $5k down, $10k and $15k down.  Just need help structuring the monthly and figuring out how it would work on the back end of the transaction once they get a new loan or refi or something.

Is it best to structure this as a lease option or simple owner financing?

They also asked me if they can cash out their loan with me early.

HELP!!!

Thank you all for your eyes on this deal.....

Scott M. · Answer

And I am not sure about your state but in MI you can put in a forfiture clause in your owner finance doc's and they give up the right to their equitable rights and you can get rid of them through a 90 day process - not a year long process.

Talk to an attorney in your area and see what the real deal is about equitable rights and the eviction process is for each type of financing your considering.

Scott M. · Answer

Hey Sam - everyone - including yourself seems to be really focused on the 15K downpayment and how to structure this deal.

However - you have yet to address the issue of the "BAD CREDIT" and the ROCKING BUSINESS.

It doesn't matter to me if you answer questions here just understand if they have bad credit they wont get a loan.

If their business isn't rocking then you will never get paid beyond 15K.

Make sure YOU understand what their credit situation is and make sure YOU have proof of their rocking biz so you can decide for yourself if it is rocking or not.

Wendy Polisi · Answer

Sam,
          
          I think you have several issues to address when deciding how to move forward with this deal.  
          
          One, as John said, why are the clients so willing to pay that far above fair market value?  And even if there is a reason for this, what is the plan when it is time for them to qualify for a mortgage?  Obviously no bank is going to lend above the value.  I think you are getting into a grey area ethically if you put someone in a Lease Purchase or Lease Option, take the option fee, and know that there is no way that they will never be able to buy the house because the value isnâ€™t there. (Obviously if they fail to repair their credit that is on them not you)
          
          One option would be to go for a longer term.  What has the average appreciation in your market been in the last five years? (Be sure you look just at townhomes because sometimes their appreciation will be significantly less than the single family homes in a given market)  If, over the next five years, your market appreciated at that rate, would the value be there?  It isnâ€™t unreasonable to expect a client to pay todayâ€™s FMV + anticipated appreciation so if the numbers make sense this could be an option.  If not, are you truly willing to hold the note for 10 years?
          
          As far as down payment, if you take 15k, (which in my option is high given a value of $250k but not unreasonable with a 5 year term) what would you do with this money?  Are you prepared to save it or otherwise financially prepared to make up the shortfall when it comes time for them to close on their mortgage?  Or can you charge enough over your payment that you can send this in to the mortgage company as a principal reduction so that you arenâ€™t coming to the table with so much cash?
          
          Unless you can charge over your mortgage payment, there really isnâ€™t any money for you in this deal.  (The down stroke will have to go towards the mortgage eventuallyâ€”assuming they take you out.) It sounds more like you just need to stop the bleeding on this property.  
          
          Will your lender modify the note and if not, when is the option ARM set to recast?
          
          As far as Lease Option vs Owner Financing, you can protect yourselves with either as long as you have good contracts.  You want to avoid equitable interest with the Lease Option.  With an owner financed deal, you want a triggering event (i.e. non-payment) that causes the contract to revert back to a straight rental.  This will avoid the equitable interest argument.  You definitely want to get an attorney if you go the Owner Financed route to make sure you arenâ€™t in a situation where you have to go through a judicial foreclosure.  
          
          Good Luck!
          
          Wendy

Brian Gibbons · Answer

I agree with Michael on the Lease Option route.

Also you could consider a Lease with a Contract for Option To Purchase.  This avoids equitable interest, in case the Tenant brings you to court.

The tenants have rent to pay and they have an option once the lease has been completed, not before.  The Option to Purchase and Purchase Agreement are prepared and held in Escrow,

Michael Rossi · Answer

I would start by looking at the laws in Hawaii regarding lease options and owner financing.  California just instituted another 90 day moratorium on foreclosures and Hawaii is a another very liberal state that could be expected to follow suit or worse.  In addition, with the socialist direction the country is taking, even longer moratoriums could occur nationwide.  THAT WOULD REALLY SUCK IF YOU ARE HOLDING PAPER VIA AN OWNER FINANCING.  If your buyers stop paying, you could EASILY  lose a year's payments while someone lives free in your house.

If lease-options are legal in Hawaii, then I think that would be a lot safer.  Take the $15K as the option premium and you're all set.

Mike

Jon Holdman · Answer

Realize that in addition to the money they already have in, you will have closing costs.  Even without any real estate agents, you'll still have a few percent in costs you'll have to pay.  Title insurance being the biggest one.

Be realistic, though.  Even if they think they want to buy this place for $377, you say its worth $250.  How are they ever going to get a loan?  Even if the housing market stabilizes, you need 50% appreciation for this place to get up to what they need to get the loan.

Why are they willing to pay such a premium?  Owner financing often commands a premium, but 50% over fair value is huge.  I smell a rat.

Nick J. · Answer

you can set your own terms, if you don't want the 15k to come from the balance then word it as such or add that much to the purchase price.

I've always taken it as "consideration" not a "down payment"

I calculate my L/O's 1 of 2 ways, either 1.5-2x's my current rate or 20% above current market rents

for instance if your interest is 7% then it's somewhere in between 10.5% and 14% depending on how motivated I want the buyers to buy or how quick I know they're going to buy.

if current market rents are say 1000 then add 20% to that and you come up with $1200, if that doesn't cover the PITI and add some cashflow then I consider option 1 instead simply b/c then I know I'm going to cashflow regardless

Sam Levitz · Answer

Thank you both...To answer your questions.....

I agree about taking the $15k....I am concerned that when I take the $15k, that will get deducted from their principle amount and then they will owe me LESS than what I owe the bank!!!  Meaning, $15k minus the $377k is $362k and I owe the bank $376k.

How do I handle that?

I am not sure if this market in this neighborhood is going to rebound within the next two years.  So maybe I should structure a 10 year note with a balloon?

How can I calculate what their payments should be to cover mine?

Or do I just say, "your payments will be $2875/mo for 10 years?"  Or "Purchase price is $377k at 7% comes to xxxxx per month."

Thank you!!!  Sam

Scott M. · Answer

When you say they have poor credit - what do you mean?

Late payments - collections type of stuff?

To much debt to their available credit?

You glossed over that pretty quick - more details.

Also - how do you know their subway is ROCKING - and what does that mean VS the debt they have on the franchise?

Nick J. · Answer

If someone tells me they've got 15k to put down I say, "Well great b/c thats exactly what I'm requiring to put down"

Don't take 5k when they've got 15k

L/O is a form of owner financing. I would be worried if they plan on getting a loan to cash you as the lender will probably not lend so much more than it's worth.

I would absolutely consider fixing your rate and lowering the payment.

If they "cash" you out without financing then I would consider it a win as long as you walk away with some cash.

If you're going to lease option make sure you do a 2 yr L/O with a 1yr extension (for an additional fee) if you owner finance I would seriously consider putting a balloon payment date in there maybe 5yrs out and a pre-payment penalty if cashed out less than 2yrs.