Wednesday, March 19, 2014

Lease-Option, Seller Financing and We Buy Homes

The Captain's warning: Nerdgasm alert, so this post won't apply to everyone.  There. I said it.

Post-Great Recession meltdown, a lot of people got bounced from their homes, both voluntarily and otherwise. Most of them became renters. Other stuff happened and still is, such as financing becoming difficult to get unless you have a credit score the size of Barry Bonds' home run total. And oh, a proliferation of hand-painted signs that said, "We Buy Homes" began decorating light posts.

What's that all about? It's investors great and small, some flaky, some traditional. Heck, the largest buyer of single family homes right now is the Blackstone Group, which, if you're looking for a house, is one of your greatest obstacles.

But with the advent of investors, low rates, low home prices, and limited access to loan, comes seller financing, very often with a lease-option. How does it work? Let's take a buyer with a low-to-middling credit score who wants to buy a house, can't get traditional financing, and who meets an investor offering a lease-option. The investor sells the buyer an option--that is, the right to buy the house at a certain price and within a specified time--and leases the house to the buyer until the option is exercised.

For example, a buyer pays $3,000 for the option to buy the investor's house for $200,000 and has three years to exercise the option. The investor also rents the house to the buyer for the three years, during which time, the buyer pays the rent on time and otherwise improves his credit score in order to get financing at the end of three years.

A common variation is to have the amount necessary for the buyer's down payment (if he exercises the option) to be added to the monthly rent. At the end of the three years, for example, the buyer may want to apply for a 5%-down loan, or $10,000 on a $190,000 loan, when he exercises his option to buy the house for $200,000. Many investors allow the option fee--in this case, the $3,000--to apply towards the down payment, meaning the buyer only needs to come up with $7,000. Over three years, he'd pay an extra $194 per month--$7,000 divided by 36. Slick, huh?

If the buyer does not exercise the option at the end of three years, the investor keeps the extra $194 monthly payments. If the buyer obtains a loan, the investor sells him the house, likely at a decent profit. That's what investors do.

But many investors also provide the financing themselves. When the buyer exercises the option, the investor carries back the deed on the house, and the payments become principal and interest payments instead of lease payments. The buyer gets title ("equitable title," in this case) and the investor gets a trust deed.

Usually, though, investors don't want to carry a loan for thirty years and insert a balloon payment into the contract. The buyer makes payments as though they serviced a traditional mortgage, but the whole loan balance becomes due--balloons--at a certain point, usually five years. If the buyer can't pay, the lender forecloses.

But the federal Dodd-Frank Law and the state SAFE Acts have something to say about this. Just what will be the topic of the next post.