05/12/2015
Options: No Down Payment Tool
One of my students recently told me how he was applying what he learned.This approach gives you 100% financing... the money comes from a hard moneylender! Sound interesting? What you are doing is making it easy for the lender to make up their own mind as to whether or not they want to play the game. Here's how it worked.
An investor liked fixing up properties. He found the type of house he wanted to buy in June of 1996. This house was for sale for $150,000. It had been on the market for six months. The market was soft during this time. When markets are soft, only the cleanest and "most ready for market" houses sell.
The house needed many cosmetic improvements as well as some minor structural modifications to be a top dollar house. The investor thought could easily be worth between $190,000 and $220,000 at the end of a years time, given various factors. These factors included a cash investment of about $10-20,000 in materials, labor and supervision on the part of the investor.
Additionally, the San Diego market was beginning to come back in June of 1996. And lastly, the house was being purchased at a discount because of all the things that needed to be done.
The investor in question wanted to structure the transaction in such a way that he could borrow a 100% of the option price at the end of eighteen months. The seller would consider an option if a.) His monthly payments were made, b.) He could get a little more for waiting c.) And the improvements would begin immediately. The seller had set the option price at $158,000. Thus if the house was really worth only $150,000 it only needed to only appreciate about 4% to be worth $158,000 at the end of a year and a half. Hindsight on this example tells us that appreciation for this particular market was around 12% between June of '96 and December of '97 so this fact worked well for the buyer. And with luck, the buyer would like to be able to borrow the additional $10,000 that he was putting into the property. At least this way he would have all his cash back. If he could get any more for his time and effort, so much the better.
Lenders have a habit at looking at refinance loan application with an eye towhatever is lower cost, what you paid for the property, or current appraisal. This same kind of outlook towards lending usually bubbles over into all sorts of situations where the buyer has possession or use of the property.
My student is a creative real estate broker. He helped this buyer and seller structure the lease option in the following fashion. Lease payments were $1200 a month. That's annual payment of $14,400. All the lease payments were to be credited to purchase at the time of purchase. As additional option consideration, buyer was required to do $20,000 worth of remodeling; decorating and repairs, with $10,000 of that being his own labor. The selling price was $192,000 rather than $158,000. This of course is the $158,000 plus the $34,000 in additional option considerations. ($14,400 in monthly payments and $20,000 in fix up.) Since $34,000 of the option consideration would be paid at the time of closing, the balance due at the time of closing was $158,000.
At time of exercise of option the real estate contract was drawn for$192,000. It showed $34,000 being paid to the seller as option consideration, which the seller acknowledged being received. A loan was requested in the amount of $160,000 which is approximately 80% loan the value. The second loan source is also being considered which would give a 90% loan the value loan. If the buyer takes the second, he will also have his fix up cash back. No matter which loan the buyer takes, the buyer will have "financed out" the majority of the purchase price. With a 90% loan to value ratio loan they will have no cash in the house whatsoever.
What about the lender? Was this all done with mirrors? Absolutely not. A copy of the option agreement was attached with the purchase contract to the loan application. Both lending sources are fully informed and are totally willing to make the loan as described above.
Now I'm not saying every lender would give you this much leeway. I also know western lenders tend to be a lot more lenient then they are in other parts of the country. Furthermore, some parts of southern California are in an up market again and lenders tend to be more generous in up markets. It isn't just that they think values are going to continue to increase for awhile, in an up market there is constant refinancing of old loans constantly giving Savings & Loans an abundant amount of cash to put out again. Thus they are anxious to make loans.
Furthermore, an appraisal of the house now all dolled up with the latest decor, showed an appraised value of $191,500. Who could ask for anything more? The ability of the property to appraise for the eventual for the contract price was a key element here. Because the property appraised so high, the remainder of the financial aspects of the transaction are a lot easier for the lending institution to go along with.
Lease options have always been an excellent way of controlling property where there is future appreciation potential. Had the lease option been written for $158,000, then the lender most likely would not have made the loan. Why? The general rule you are fighting is that lenders loan either contact price or appraised value, which ever is less.
Yes, there was a contrived way of putting together the price, but by the book, the contract price was $192,000, thus fitting the lenders mold. This control can often be obtained with far fewer dollars than what would be necessary in an outright purchase. Furthermore, in this example where major fix up repair decorating outlays are planned and these outlays are anticipated to greatly enhance the value of the property, the lease option is a perfect tool. Combined with this the manner in which the purchase price was computed and you have additional advantage with a lease option of being able to recoup most all if not all of your acquisition cost at the time of exercise of option.
The broker had to wait to get his commission, which was paid by the buyer. Lastly, a seller, who was worried about not being able to hold on to his house, got relief, and got a price he agreed to in cash.
