Shimshi Kahn was frustrated by the recent mortgage-rate hikes. The cost of financing real estate had become prohibitive, and the housing market was slow. Homeowners were having a hard time selling, as prospective home buyers couldn’t make the numbers pencil in with such high interest costs. And even if they somehow found a buyer, who could swing the swollen mortgage payments? Commercial real estate was similarly gummed up.
What creative options can be explored?
Creativity for the Win-Win
In a challenging mortgage market, potential home buyers and investors are finding it difficult to proceed with traditional first mortgages. Sellers, meanwhile, don’t want to lower their prices or be forced to swap existing low-rate mortgages for those with today’s much higher rates. In this environment, one may need to get creative and explore alternatives to run-of-the-mill mortgages. Those who think outside the box may be pleasantly surprised that the numbers can work. Bringing imaginative financing options to the table can help buyers and sellers break market stalemates, opening up win-win scenarios.
Assuming the Seller’s Mortgage
One option is for the buyer to “assume” the seller’s existing mortgage if permitted by the lender. This arrangement allows a new owner to take over the seller’s mortgage and continue making payments based on the original terms. This approach can be a game changer, as it may involve lower interest rates, better terms, and fewer closing costs compared to obtaining a new mortgage. Assumable loans are relatively rare in the traditional housing market but are not unusual in the commercial world. It’s something to ask about.
In seller-financing transactions, the seller acts as the lender, allowing the new owner to make payments directly to them instead of relying on a traditional lending institution. Seller financing enables the parties to customize the terms, such as the down payment, interest rate, and repayment period, based on their financial situations and preferences. Some sellers may be willing to “take back paper” at attractive rates if they get their desired sale price and don’t need all the cash immediately to buy another property. An attractive assumable loan topped with seller financing can become a superior deal structure.
A more esoteric version of owner financing is the land contract (though it has nothing to do with land). In this structure, deeds are held in escrow as the buyer makes payments, usually with an interest rate built in, to the seller over an agreed-upon period. The buyer does not receive legal ownership immediately, instead building equity rights to the property as payments accrue. Once all the agreed-upon payments are completed, title transfer is completed. Land contracts, also known as contracts for deed or installment sale agreements, are legally convoluted, but read on; this gets really interesting.
Wraparound Land Contract
Land contracts have a bad reputation since historically, they were used to exploit unsophisticated buyers who couldn’t qualify for conventional mortgages with more borrower protections built in. So, why might this legal contortion be useful to us? In situations where a property has advantageous but unassumable debt, a wraparound land contract may be able to twist the existing loan into an assumable position.
This complex arrangement involves creating a new land contract while maintaining the existing first mortgage. Since the original owner keeps the title, lenders may be obligated to keep the loan intact despite the unfolding land contract. The buyer makes payments to the seller based on the agreed-upon terms of the wraparound contract, and the seller, in turn, continues making payments on the underlying mortgage. If the original interest rate is low enough, the payments required to make a deal may be much lower than new mortgages available under a typical sale, even if the seller builds additional owner financing on top.
Walking in Legal Thickets
These wraparounds were very popular in the late 1970s, when mortgage rates skyrocketed into double digits. Unsurprisingly, lenders were unhappy to be stuck with these low-interest rate structures, and the Federal Housing Authority, which backs most home mortgages, explicitly disallowed them. So, land contracts are thickets, not to be walked through lightly. But I have seen wraparounds used in commercial real estate, legally and effectively. If you use one in this environment, I’d love to hear about it.
Adjustable-Rate Mortgage (ARM)
I’ve never been an ARM fan but will mention them anyway. ARMs offer an initial fixed interest rate for a specific period, after which the rate adjusts periodically based on market conditions. ARMs usually have start rates below fixed-rate mortgages. Therefore, in theory, ARMs can save money for buyers who sell the property before rates adjust or if they’re plain lucky and rates don’t rise. But many people, even supposedly savvy investors, have gotten badly burned with ARMs. Anyway, ARMs today are being quoted at higher rates than fixed, so there’s really nothing to see here.
First Mortgage Buydown
Another “honorable” mention is temporary mortgage buydowns. These offerings are largely sales gimmicks from national home builders and mortgage bankers who need to move product despite high mortgage rates. Rather than lowering the sales prices or mortgage rates, they temporarily escrow some money upfront to lower monthly mortgage payments. The underlying mortgage, however, is full-priced, and full payments kick in as soon as the escrow account empties, typically in just a year or two. Take the discount, if offered, but don’t get fooled into thinking this is some kind of mortgage magic.
There’s Money in the Weeds
It is strongly advisable to consult with qualified financial and legal professionals before going off the well-trodden path of conventional mortgages. And, of course, you need to be careful about ribbis issues when financing between Jews is on the table. You can trip up badly if you miss even a small detail in the fine print. But those willing to carefully wend through the weeds of real estate finance may be handsomely rewarded for doing so.