LET’S
GET CREATIVE!
Although,
we have discussed only a limited number of actual purchase transactions, it is
vital that you realize that the creative financing techniques and principles that you have learned are anything
but limited! In one way or another, these creative
financing techniques form the
structure of about 98% of all real estate transactions that fall into the
category of "creative financing", (anything other than
making the standard down payment and getting a loan from the bank).
These principles are not mutually exclusive.
In other words, using one principle, does not exclude the use of an
altogether different principle within the same transaction.
These principles are the building blocks that will allow you to create
the necessary financing structure for almost any purchase...
We
are now going to discuss one more real estate transaction.
Only this time, putting this deal together is going to take a combination
of many of the principles we have learned...
Here
is the situation:
This
property is worth $115,000 but because the seller absolutely has to have cash
right away, he is willing to sell it for $100,000, but only if he receives all
cash. Furthermore, the property has
a $20,000 non-assumable loan against it. Since
the seller owes $20,000 the buyer needs to be able to raise $80,000 cash for the
seller.
The
buyer sold a property last year and is still owed $10,000.
Plus, his car is paid off and worth about $8,000.
He is currently unemployed and consequently, not able to qualify for a
standard type of loan; but that doesn't matter anyway because right now, even if
he could qualify income wise, he only has $100 in his checking account and
doesn't have the 20% down that would be required on a non-owner occupied loan.
And yesterday-- his dog died. Sorry,
I couldn't help it.
Anyway,
in spite of his shaky financial situation, because of his thorough
understanding and correct application of our real estate financing principles,
he is about to raise $80,000 dollars and acquire about $15,000 in equity without
taking one penny out of his pocket.
Here's
how...
1) Assume the "unassumable",
first mortgage of $20,000 by using a wrap around mortgage.
Remember, if the financing company has ample
protective equity, they will usually lend even if you
don't have a job. They
will usually lend up to 70% of the property value,
(not price), minus any existing
mortgages. Although, he is buying the property for $100,000, it is worth
$115,000, so their loan will be 70% of
$115,000 not 70% of $100,000. 70%
of $115,000 equals $80,500. There
currently exists a $20,000 first mortgage against the property so, the finance
company will lend $80,500 minus the $20,000 or $60,500...
So what does the buyer do?
2) He gets a second mortgage from the finance company for $60,500.
(The buyer has now raised
$60,500 but still needs $19,500. But
where to get it?)
With
the assets that the buyer has, namely, the $10,000 owed him and the $8,000 car,
he should have no problem using them as collateral to
raise 55% of their value or about $10,000.
Most banks would consider that to be a very secure investment.
However, if they still balked at making the loan, he could offer a
portion of his soon to be realized equity in the property he is buying as extra
collateral. For most banks, that
would be an irresistible combination of security for their loan.
3) Borrow $10,000 using present assets as security. (The buyer has now raised a total of $70,500. $60,500 +
$10,000 = $70,500. To make this
deal work, he needs $80,000 or an additional $9,500. Where to get it?)
We
can use the seller's equity to create a saleable note;
a note that can be sold to a financial institution or mortgage investor. For
a note to be marketable it must have an ample rate of return, i.e. high interest
rate, and at least 20% protective equity. In other words, the total of the
first, second and the mortgage we are creating cannot exceed 80% of the
property's value.
The
subject property's value is $115,000. 80%
of $115,000 is $92,000. There is
already a $20,000 first plus, a second mortgage of $60,500 for a total of
$80,500 in loans. This means that
if we want a mortgage that the seller can sell for cash, it cannot be for more
than $11,500.
4) Execute a third mortgage in favor of the seller in the amount
of $11,500. (The seller can now
sell the note for cash. If he sells it at a 15% discount he will then realize 85% of
the value of the note in cash or $9,775.)
Let's
now analyze exactly what just happened:
1) Assumed (by wraparound or subject to)....$20,000...cash
generated..$0
2) Borrowed (second
mortgage).......... 60,500...cash
generated...60,500
3) Borrowed against present
assets..... 10,000...cash generated...10,000
4) Created saleable note (3rd mrtg)
..11,500...cash generated....9,775
$102,000.................( $80,275 cash generated )
Although,
the seller was asking only, $100,000 his actual objective was to net $80,000
cash out of the sale. Due to the discounting of the saleable note, raising
$80,000 cash for the seller actually necessitated a sales price of $102,000.
However, paying $102,000 for a property that is worth $115,000 and buying
it without any down payment is not bad.
Although, it is highly unlikely that you will ever need to create a financing structure as convoluted as the one just examined, it's important to realize that, if necessary, it can be done. The proper application of these creative financing techniques and principles can accommodate almost any financing need. Next Chapter
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