by Mark Murphy
What is Creative Real Estate Financing?
It’s been a long time since San Diego real estate investors have had so much inventory from which to choose. Inventory levels are high, interest rates are low and rents are rising throughout the area. It’s a depressed market and San Diego has become an investor’s dream-come-true.
Unfortunately, obtaining a conventional mortgage loan from a bank, credit union or savings and loan can be a difficult proposition. If the real estate buyer is self-employed, has a low FICO score and/or doesn’t have substantial liquid assets and verifiable employment, getting conventional or government financing may be very difficult. That makes it a tough market for both sellers and buyers.
The is hope, though, when sellers, buyers AND real estate agents understand the options and possibilities of creative financing, which refers to non-traditional means of real estate financing. This financing is generally used to purchase or finance a property with the home buyer or investor using as little of his or her money as possible. This is sometimes jokingly referred to as using OPM or “other people’s money.”
Types of Creative Financing
As the name implies, the possibilities and ways to finance real estate are almost limitless when it comes to creative financing. Below are four ways that the San Diego real estate investor might want to creatively finance a particular property.
Installment Sale: If property is owned free and clear, the owner might want to carry the mortgage or note and collect the interest–instead of that money going to the bank. For example, a seller might sell a home, pay income taxes on part of the gain and then stick the balance of the proceeds into a CD that pays 1 percent interest. Instead, the seller might carry the note at 5 percent interest and pay taxes on a lower amount as the money is received each month. This would also benefit the borrower, who might not be able to qualify for a conventional loan.
AITD or Wrap-Around Mortgage
An All-Inclusive-Trust-Deed or Wrap-Around mortgage occurs when the seller carries the note and “wraps” it around existing underlying financing, which remains in the seller’s name. This is one way the real estate seller can make money on OPM. For example, if the seller has an original mortgage in the amount of $100,000 at 4 percent interest with 14 years remaining on the note, he or she might sell the home for $300,000 with $30,000 or 10 percent down payment. He might then carry a note for 20 years in the amount of $270,000 at 6 percent interest. In that case, seller would make 2 percent interest on $100,000 for 14 years and 6 percent interest on the balance for the 20 years. At the end of 14 years, seller would receive 6 percent interest on the full balance.
Lease Option: With this form of financing, title to the property remains in the seller’s name and does not transfer to the buyer until a mutually-agreed upon event happens at a future date. That “event” might include, for example, the buyer obtaining financing to cash out the seller, at which time title would go into the buyer’s name. Option money is generally non-refundable, but may go towards eventual purchase money for the home.
Subject-To Financing: If a seller’s underlying financing will allow for the loan to be assumed, then a buyer might compensate the seller for his or her equity and then assume the underlying loan–or taking title to the home “subject to” existing financing. The seller might also agree to “carry the note” on a second or third trust deed or note. These loans are reportedly difficult to find in today’s market because most conventional loans are not assumable.