Seller Financing Instructor Materials PDF

13 Seller Financing Learning Objectives After completing this lesson, students should be able to… Discuss when and why seller financing might be used and how it works Define “seller second” and describe how it can be used to supplement...

13 Seller Financing Learning Objectives After completing this lesson, students should be able to… Discuss when and why seller financing might be used and how it works Define “seller second” and describe how it can be used to supplement either a new loan or an assumption Understand how seller financing might be used as primary financing Describe how a land contract differs from a mortgage or deed of trust Explain how wraparound financing works List alternatives to seller financing, such as buydowns or lease arrangements Summarize an agent’s responsibilities in a seller-financed transaction Suggested Lesson Plan 1. Give students Exercise 13.1 to review the previous chapter, “VA-Guaranteed Loans.” 2. Provide a brief overview of Chapter 13, “Seller Financing,” and review the learning ob- jectives for the chapter. 3. Present lesson content: How Seller Financing Works When and Why Seller Financing is Used EXERCISE 13.2 When and why seller financing is used © 2018 Rockwell Publishing  Seller Financing Instructor Materials Seller Seconds – Supplementing a new loan – Supplementing an assumption EXERCISE 13.3 Seller seconds Seller Financing as Primary Financing – Unencumbered property – Land contracts – Encumbered property: wraparound financing Alternatives to Seller Financing – Buydowns – Contributions to closing costs – Equity exchanges – Lease arrangements Legal Responsibilities in Seller-Financed Transactions – Disclosure statements – Buyer’s ability to repay – Agent’s liability EXERCISE 13.4 Land contracts and seller financing alternatives 4. End lesson with Chapter 13 Quiz. Chapter 13 Outline: Seller Financing I. How Seller Financing Works A. A seller can use a promissory note and security instrument to finance the buyer’s purchase; such a loan is known as a purchase money loan or seller carryback loan B. A seller may also use a land contract, where the buyer takes possession of the prop- erty but the seller retains title until the price has been paid in full C. Seller financing is usually secondary financing, where a “seller second” supplements an institutional first mortgage II. When and Why Seller Financing is Used A. If interest rates are high and buyers have difficulty qualifying for loans, the only way a seller may be able to sell the property is by financing part of the purchase price B. Sellers may use seller financing as a marketing tool; buyers may pay more for a house if they can get favorable seller financing terms C. Seller financing may have tax advantages: if payments are made over a period of years, the seller doesn’t have to report the full profit from the sale in the first year 2  Chapter 13: Seller Financing EXERCISE 13.2 When and why seller financing is used III. Seller Seconds A. Often, seller financing is secondary financing: the seller accepts a second mortgage (a “seller second”) for the difference between the primary loan amount and the pur- chase price B. Supplementing a new loan 1. The seller second must meet the primary lender’s requirements; for instance, for a conventional loan, the primary lender might state that the total financing can’t exceed 95% of the sales price, and the second loan may not require a balloon pay- ment less than five years after closing 2. A buyer considering a seller second needs to consider how much he has for a downpayment, the total monthly payment he can qualify for, and how large the balloon payment for the seller second will be 3. A seller considering a seller second needs to think about whether cash flow and yield will be adequate, possible negative tax consequences (such as the imputed interest rule), and lien priority C. Supplementing an assumption 1. A seller second can supplement a buyer’s assumption of an existing loan; the buyer will make a monthly payment to the seller, as well as making the monthly payment the seller has been making to the lender 2. If the loan has a due-on-sale clause, an assumption isn’t possible unless the lender agrees to it 3. Regardless of whether there is a due-on-sale clause, the lender’s consent is neces- sary for the seller to be released from liability EXERCISE 13.3 Seller seconds IV. Seller Financing as Primary Financing A. Unencumbered property 1. Seller financing is straightforward if the seller owns the property free and clear 2. While lien priority is not as much of a concern with primary seller financing, the seller must make sure that taxes and special assessment liens are paid so that the government doesn’t foreclose 3. Escrow account can be set up to handle the buyer’s tax and hazard insurance pay- ments 4. If a seller is willing to provide substantial financing but needs cash at closing, a possibility is seller financing with an institutional second mortgage B. Land contracts 1. A seller providing primary financing might choose to use a land contract (also known as a conditional sales contract or installment sales contract) instead of a mortgage 3  Seller Financing Instructor Materials 2. Under a land contract, the seller (or vendor) retains legal title to the property until the buyer (or vendee) pays off the entire purchase price in installments 3. A land contract is not accompanied by a promissory note; the contract describes the terms of sale and the financing arrangements 4. For some land contracts, if a vendee defaults on the contract obligation, the vendee’s rights in the property are terminated and the vendor retains all payments made so far; this remedy is known as forfeiture 5. Courts won’t necessarily allow forfeiture, depending on how long the vendee has been making payments 6. The main disadvantage of a land contract is the expense and delay of court pro- ceedings in the event of breach 7. Lenders are not likely to offer institutional secondary financing if the primary financing is through a land contract C. Encumbered property: wraparound financing 1. With a wraparound, the property remains subject to the existing mortgage (or underlying loan), and the seller continues to make payments 2. Each month, the buyer makes a payment to the seller, and the seller uses a portion of that payment to make the payment on the underlying loan 3. A wraparound can use a mortgage, a deed of trust (called an all-inclusive deed of trust), or a land contract 4. The underlying loan cannot have a due-on-sale clause; it is never a good idea to use a “silent wrap,” where the lender isn’t informed of the sale of the property 5. Wraparound financing can be attractive if rates have been rising; it allows the buyer to finance a purchase at a below-market rate on the total amount financed while the seller receives an above-market rate on the credit extended V. Alternatives to Seller Financing A. Buydowns: the seller may assist a buyer with a buydown, by paying discount points to reduce the buyer’s interest rate B. Contributions to closing costs: the seller may pay some of the buyer’s closing costs, which can be more helpful than a price reduction for the same amount C. Equity exchanges: a seller may accept other assets from a buyer in addition to cash D. Lease arrangements: a seller may lease a property to a buyer for a time before the buyer purchases it, either through a lease/option or a lease/purchase 1. A lease/option involves a lease for a specific term along with an option to pur- chase the property at a specified price 2. The option money and/or the rental payments may be applied toward the pur- chase price in a lease/option, either deducted from the sales price or treated as part of the downpayment 3. In a lease/purchase, buyer and seller sign a purchase contract along with the lease, so that deciding not to purchase at lease’s end means a breach of the contract 4  Chapter 13: Seller Financing VI. Legal Responsibilities in Seller-Financed Transactions A. An agent should recommend that both parties get legal and tax advice, and have doc- uments reviewed by a lawyer, before proceeding with seller financing B. Disclosure statements: some states require disclosure forms when a third party (such as a real estate agent) helps arrange seller financing C. In some seller-financed transactions, an agent may be responsible for evaluating the buyer’s ability to repay the loan D. Agent’s liability: a disclosure statement does not limit an agent’s liability 1. An agent who encourages an unwise financial arrangement might be liable for breach of fiduciary duties 2. An agent who arranges seller financing might create an inadvertent dual agency EXERCISE 13.4 Land contracts and seller financing alternatives Exercises EXERCISE 13.1 Review exercise To review Chapter 12, “VA-Guaranteed Loans,” have students answer the following questions. 1. What fee does a VA borrower pay at closing instead of a mortgage insurance premium? 2. What document does the VA issue to veterans that enables them to apply for a VA loan? 3. What is the guaranty amount available to a particular veteran known as? 4. What is the document issued by a VA-approved appraiser concerning the security property’s value? 5. What’s the term for the income that’s left over after the monthly shelter expense, all other recurring obligations, and certain taxes are subtracted from a VA bor- rower’s gross monthly income? 6. What happens when a veteran repays a loan in full with the proceeds from the sale of the property? Answers: 1. Funding fee 4. Notice of Value or Certificate of Reasonable Value 2. Certificate of Eligibility 5. Residual income 3. Entitlement 6. Restoration of entitlement 5  Seller Financing Instructor Materials EXERCISE 13.2 When and why seller financing is used Match the correct term to the descriptions below. Purchase money loan Installment sale Land contract Loan origination fee Seller second High market interest rates Promissory note Blanket loan ______ 1._When a home buyer gives a mortgage to the seller. ______ 2._A tax advantage of seller financing is that the seller can report the transaction to the IRS as one of these. ______ 3._A seller financing arrangement in which the buyer takes possession of the property, but the seller retains title until the price is paid in full. ______ 4._Financing provided by a seller to supplement the buyer’s institutional loan. ______ 5._One of the charges a buyer can avoid or reduce with seller financing, to make the transaction more affordable. ______ 6._These make seller financing especially attractive to both sellers and buyers. Answers: 1. PURCHASE MONEY LOAN. When a seller extends credit to the buyer and the buyer gives the seller a mortgage or a deed of trust, it’s called a purchase money loan. 2. INSTALLMENT SALE. With an installment sale, the seller can defer payment of some of the taxes on the gain. 3. LAND CONTRACT. With a land contract, the buyer receives possession immediately, but doesn’t take title until the contract price is paid in full. 4. SELLER SECOND. A seller may provide either primary financing or secondary financing that supplements an institutional first mortgage. Secondary financing provided by the seller is called a seller second. 5. LOAN ORIGINATION FEE. Institutional lenders usually charge a loan origination fee; sellers providing financing typically do not. With seller financing as primary financing, the origination fee is avoided altogether. With a seller second, the origi- nation fee for the primary loan is reduced, because the loan amount is smaller and the fee is a percentage of the loan amount. 6. HIGH MARKET INTEREST RATES. When interest rates are high, it’s harder for sell- ers to find a buyer, and harder for buyers to afford a home. Seller financing can help both a seller and a buyer achieve their goals. 6  Chapter 13: Seller Financing EXERCISE 13.3 Seller seconds Discussion Prompts: Why does the primary lender care about the terms of a seller second? What are some of the key considerations for a buyer who’s considering a financ- ing arrangement involving a seller second? What are some of the key considerations for a seller who’s considering offering a buyer a seller second? When would an assumption plus a seller second be allowed? Analysis: A seller second (like any secondary financing) might have terms that could make default or a loss on the primary loan more likely. For example, if the seller second required a large balloon payment after only two years, it might be very difficult for the buyer to make that payment. The buyer could end up defaulting on the seller second, the primary loan, or both. Even though the primary loan has higher lien priority, foreclosure on secondary financing can significantly impair the primary lender’s security interest and/or result in a loss on the primary loan. A buyer should consider: 1) how much cash he has available for the downpay- ment; 2) whether he’ll be able to qualify for (and comfortably pay) the combined payment on the two loans; and 3) how he will make the balloon payment (if one is required for the seller second) when the time comes. A seller should consider: 1) whether the cash flow from the seller second will be adequate; 2) how the return on the seller second will compare to the return on alternative investment possibilities; 3) the tax consequences of the transaction; and 4) how she may be affected by lien priority. An assumption plus a seller second will work only if there’s no due-on-sale clause in the loan the buyer would assume, or if the lender agrees to the assumption. The lender’s consent will always be needed if the seller wants to be released from liability. 7  Seller Financing Instructor Materials EXERCISE 13.4 Land contracts and seller financing alternatives Discussion Prompt: Briefly explain how each of the following arrangements works. 1. Land contract 2. Buydown 3. Lease/option 4. Lease/purchase 5. Equity exchange Answers: 1. In a land contract, the buyer takes possession of the property immediately but pays the contract price to the seller in installments, instead of in a lump sum. While the buyer (the vendee) is paying off the contract, the seller (the vendor) retains legal title to the property. The vendee has only equitable title. When the contract has been paid off, the vendor gives the vendee a deed transferring legal title. 2. In a buydown, the seller agrees to pay points to the buyer’s lender. In return, the lender lowers the interest rate on the buyer’s loan, either for a certain number of years (a temporary buydown) or for the life of the loan (a permanent buydown). This makes it easier for the buyer to qualify for the loan, and also makes the pay- ment more affordable. 3. In a lease/option, the tenant/optionee leases the property for a certain term and also gives the landlord/optionor nonrefundable option money. During the lease term, the buyer/tenant has the option of purchasing the property at a specified price. The option money and/or the rental payments may be applied toward the purchase price. 4. In a lease/purchase, the tenant/buyer and the landlord/seller execute both a lease and a purchase agreement at the same time, and the tenant/buyer also provides an earnest money deposit. If the tenant/buyer decides not to purchase the property by the end of the term, it’s a breach of contract, so she forfeits the deposit. 5. In an equity exchange, the seller agrees to accept certain personal property instead of cash as part of the downpayment from the buyer. 8  Chapter 13: Seller Financing Chapter 13 Quiz 1. Rather than using an institutional loan, a seller 6. If a seller is willing to finance most of the pur- extends credit to a buyer and the buyer gives chase price but needs some cash at closing, a the seller a deed of trust. This would be known possible solution is: as a/an: A. a land contract A. assumption B. a wraparound loan B. land contract C. an institutional loan plus a seller second C. purchase money loan D. primary seller financing plus an institu- D. wraparound loan tional second 2. Which of the following would NOT be a reason 7. In a land contract, the seller is also known as for a seller to use seller financing? the: A. It can help attract a buyer at times when A. trustee interest rates are very high B. trustor B. It may allow the seller to charge a higher C. vendee price for the house in exchange for other D. vendor benefits C. It provides a seller who needs to be cashed 8. Who holds legal title during the repayment out with a large lump sum period of a land contract? D. It provides tax benefits A. Trustee B. Trustor 3. Seller financing can provide significant tax C. Vendee benefits for a seller because it involves: D. Vendor A. an installment sale B. casualty loss 9. The penalty for the vendee’s breach of a land C. depreciation contract may be: D. recapture A. forfeiture B. garnishment 4. A seller second is used to supplement a/an: C. liquidated damages A. land contract D. relinquishment B. new institutional loan C. assumption 10. How does wraparound financing work? D. Either B or C A. An existing loan wraps around the seller financing 5. A seller might be affected by the IRS’s imputed B. The buyer assumes an existing loan and interest rule if the: receives supplemental financing A. seller finances too large a portion of the C. The seller retains legal title to the property total sales price while the buyer repays the purchase price B. seller second includes a balloon payment D. The seller financing wraps around the un- C. seller second is for too long a loan term derlying loan D. seller second uses an interest rate that is too far below market rates 9  Seller Financing Instructor Materials 11. A deed of trust used in a wraparound arrange- ment may be known as a/an: A. all-inclusive trust deed B. blanket mortgage C. package mortgage D. underlying loan 12. A “silent wrap” is: A. a commonly accepted practice B. a failure to notify the underlying lender of the wraparound arrangement C. an arrangement where the buyer assumes the underlying loan D. used when the underlying loan is larger than the planned seller financing 13. A common way for a seller to assist a buyer is to use a/an ____, in which the seller’s proceeds will be reduced by a certain amount at closing, in exchange for a lower interest rate for the buyer. A. assumption B. buydown C. equity exchange D. lease/option 14. A buyer doesn’t have adequate cash to close a proposed transaction, but the seller agrees to ac- cept a sailboat owned by the buyer in exchange for a $20,000 reduction in the purchase price. This is a/an: A. buydown B. equity exchange C. lease/purchase D. Section 1031 exchange 15. In a lease/option: A. the buyer gives a noncash asset to the seller in exchange for a reduced sales price B. the buyer leases the property for a period of time and may choose to buy it at a specified price during the lease term C. the buyer leases the property, but is com- mitted to buying it at the end of the lease D. the seller pays discount points to the lender on behalf of the buyer 10  Chapter 13: Seller Financing Answer Key 1. C. A purchase money loan is any loan 8. D. The vendor, or seller, retains legal title where the seller extends credit to the until the vendee has paid off the entire buyer instead of actually supplying purchase price. The vendee has the loan funds, and the buyer repays the right to possess the property, which in price in installments over time. this context is sometimes called equi- table title. 2. C. Seller financing isn’t an option for a seller who needs to be cashed out right 9. A. The penalty for breach of a land con- away, such as a seller who needs all of tract may be forfeiture, in which all her net equity to buy another house. payments are retained by the vendor and the vendor may retake possession 3. A. Because the buyer pays the seller in in- of the property immediately. Depend- stallments over a number of years, the ing on state law and the circumstances seller can defer payment of part of the of the case, though, a judge might not taxes and the profit from the sale may allow forfeiture. be taxed at a lower rate. 10. D. In a wraparound arrangement, the seller 4. D. A seller second may be used to financing is larger than the balance supplement either a new loan from an owed on the existing mortgage, which institutional lender, or an assumption remains in place. The buyer makes of an existing loan. monthly payments to the seller, some of which the seller will use to 5. D. If a seller offers financing using an in- continue making payments on the un- terest rate that is too far below market derlying loan. rates, the Internal Revenue Service will treat a portion of the principal re- 11. A. When a deed of trust is used in a wrap- ceived each year as interest (which is around, it is often referred to as an taxable). all-inclusive trust deed. 6. D. A seller who needs some cash at 12. B. In a silent wrap, a seller tries to get closing, such as the cash for a small around an underlying loan’s due-on- downpayment on a new property, may sale clause by using a wraparound land choose to offer primary financing in contract and not notifying the lender conjunction with a supplemental insti- of the arrangement. A real estate agent tutional loan. should not get involved in a silent wrap. 7. D. The seller in a land contract is also 13. B. In a buydown, the seller gives a lump known as the vendor. sum to the lender at closing, in ex- change for a lower interest rate for the buyer. 11  Seller Financing Instructor Materials 14. B. In an equity exchange, the buyer gives the seller a noncash asset (such as an item of personal property) in exchange for a reduction in the cash sales price. 15. B. A lease/option gives a tenant the op- tion of buying the property for a specified price during the lease term. The tenant will usually pay nonrefund- able option money at the beginning of the lease term, which may be applied to the purchase price. 12  Chapter 13: Seller Financing PowerPoint Thumbnails Use the following thumbnails of our PowerPoint presentation to make your lecture notes. Financing Residential Real Estate Lesson 13: Seller Financing © 2018 Rockwell Publishing Introduction This lesson will cover: ⚫ how seller financing works ⚫ why seller financing is used ⚫ forms of seller financing ⚫ alternatives to seller financing ⚫ agent’s responsibilities in seller-financed transactions © 2018 Rockwell Publishing How Seller Financing Works Two ways for seller to finance buyer’s purchase: ⚫ purchase money loan ⚫ land contract © 2018 Rockwell Publishing 13  Seller Financing Instructor Materials How Seller Financing Works Purchase money loan Purchase money loan: mortgage or deed of trust given by buyer to seller (instead of third-party lender). ⚫ Buyer makes installment payments to seller. ⚫ Seller is mortgagee or beneficiary, with right to foreclose in case of default. ⚫ Seller is extending credit to buyer, not providing loan funds. ⚫ Also known as a seller carryback loan. © 2018 Rockwell Publishing How Seller Financing Works Land contract Land contract: buyer (vendee) takes possession of property, but seller (vendor) retains title until contract price paid in full. ⚫ Alternative to purchase money loan. ⚫ Seller extends credit to buyer. © 2018 Rockwell Publishing How Seller Financing Works Primary or secondary financing Seller financing may be: ⚫ primary financing ⚫ seller is buyer’s main or only source of financing for purchase ⚫ secondary financing (seller second) ⚫ supplements primary loan from institutional lender ⚫ covers part of downpayment or closing costs required for primary loan © 2018 Rockwell Publishing 14  Chapter 13: Seller Financing How Seller Financing Works Choosing finance instrument Seller generally decides which type of finance instrument to use based on remedies available if buyer defaults. ⚫ Real estate lawyer should prepare/review. ⚫ Deed of trust: trustee must be appointed. ⚫ If transaction involves institutional financing, seller probably can’t use land contract. © 2018 Rockwell Publishing Why Seller Financing is Used Seller financing can: ⚫ attract buyers when interest rates are high ⚫ help buyer qualify for institutional loan ⚫ enable seller to charge higher price ⚫ provide tax benefits to seller © 2018 Rockwell Publishing Why Seller Financing is Used Seller financing: ⚫ seller isn’t bound by institutional policies regarding yields, loan-to-value ratios, or qualifying standards ⚫ not an option for seller who needs to be cashed out quickly © 2018 Rockwell Publishing 15  Seller Financing Instructor Materials Seller Seconds Seller second: ⚫ buyer paying most of purchase price with institutional loan ⚫ seller accepts second mortgage for remainder © 2018 Rockwell Publishing Seller Seconds Supplementing a new loan Seller second supplementing new institutional loan must meet lender’s standards. ⚫ Many kinds of seller seconds can comply with lender rules. © 2018 Rockwell Publishing Supplementing New Loan Buyer’s situation Three factors in buyer’s financial situation shape design of seller second: ⚫ funds available for downpayment ⚫ total monthly payment buyer qualifies for ⚫ balloon payment © 2018 Rockwell Publishing 16  Chapter 13: Seller Financing Supplementing New Loan Buyer’s situation May be easy to refinance seller second with balloon payment if: ⚫ property has appreciated substantially ⚫ interest rates are low But if interest rates are high or property has lost value, refinancing could be difficult. © 2018 Rockwell Publishing Supplementing New Loan Seller’s situation Seller’s evaluation of second: ⚫ cash at closing ⚫ monthly income ⚫ timing of payoff (balloon payment) ⚫ yield on investment ⚫ tax consequences ⚫ lien priority © 2018 Rockwell Publishing Seller Seconds Supplementing an assumption Seller second can supplement buyer’s assumption of seller’s existing mortgage. ⚫ Buyer makes payments on seller second to seller. ⚫ Buyer takes over monthly payments on seller’s existing mortgage. © 2018 Rockwell Publishing 17  Seller Financing Instructor Materials Seller Seconds Supplementing an assumption Assumption only possible if: ⚫ existing mortgage doesn’t have due-on- sale clause, or ⚫ lender agrees to assumption. ⚫ Needed to release seller from liability. ⚫ Usual underwriting standards to evaluate buyer assuming loan. © 2018 Rockwell Publishing Summary Seller Seconds Purchase money loan Land contract Seller second Assumption © 2018 Rockwell Publishing Seller Financing as Primary Loan Unencumbered property Seller financing is most flexible when seller has clear title to property. ⚫ Buyer and seller negotiate price and terms. ⚫ Buyer needs less cash for seller financing. ⚫ No discount points or origination fee. ⚫ Lower closing costs. © 2018 Rockwell Publishing 18  Chapter 13: Seller Financing Unencumbered Property Protecting seller’s security First lien position if finance instruments are recorded. Seller should still be concerned with: ⚫ property taxes ⚫ special assessment liens ⚫ hazard insurance © 2018 Rockwell Publishing Unencumbered Property Protecting seller’s security Failure to pay taxes or insure property is default under most finance instruments. ⚫ Seller can require impound account. © 2018 Rockwell Publishing Unencumbered Property Institutional second Buyer might want to supplement seller financing with secondary financing from lender. ⚫ Seller should investigate terms of proposed second loan before agreeing to transaction. ⚫ Can buyer afford monthly payments on both loans? ⚫ Does second have provisions that make default likely? © 2018 Rockwell Publishing 19  Seller Financing Instructor Materials Unencumbered Property Land contracts Seller may choose to use land contract instead of mortgage or deed of trust. Also known as: ⚫ contract for deed ⚫ bond for deed ⚫ conditional sales contract ⚫ installment sales contract ⚫ installment land contract ⚫ real estate contract © 2018 Rockwell Publishing Land Contracts How contract sale works Land contract: seller (vendor) keeps title to property until buyer (vendee) pays off entire purchase price in installments. ⚫ Legal title: vendor’s title during contract term. ⚫ Equitable title: right of vendee to possess and enjoy property. © 2018 Rockwell Publishing Land Contracts How contract sale works Contract: ⚫ not accompanied by promissory note ⚫ states all terms of sale and financing arrangement between vendor and vendee ⚫ should always be recorded © 2018 Rockwell Publishing 20  Chapter 13: Seller Financing Land Contracts Remedies for breach of contract Forfeiture: penalty if vendee breaches contract. ⚫ Vendee’s rights in property are terminated. ⚫ Payments may be kept by vendor as liquidated damages. ⚫ Vendor may retake possession of property immediately. © 2018 Rockwell Publishing Land Contracts Remedies for breach of contract Vendee refusing to leave means legal action to clear title and remove vendee from property. ⚫ Drawback for vendor: may take months. © 2018 Rockwell Publishing Land Contracts Remedies for breach of contract Judge may: ⚫ enforce contract as written ⚫ give vendee time to pay off contract balance ⚫ allow vendee to reinstate contract by paying delinquent payments plus interest ⚫ order sheriff’s sale of property © 2018 Rockwell Publishing 21  Seller Financing Instructor Materials Land Contracts Remedies for breach of contract In some states: ⚫ vendee’s rights based on timing of default ⚫ law may not allow forfeiture if contract’s unpaid balance is comparatively small © 2018 Rockwell Publishing Land Contracts Advantages and disadvantages Advantages for vendor: ⚫ legal owner until contract paid in full ⚫ may reacquire property in event of default © 2018 Rockwell Publishing Land Contracts Advantages and disadvantages Disadvantages for vendor: ⚫ delay and expense of court proceedings ⚫ uncertainty of trial results © 2018 Rockwell Publishing 22  Chapter 13: Seller Financing Land Contracts Advantages and disadvantages Advantages for vendee: ⚫ slow court proceedings © 2018 Rockwell Publishing Land Contracts Advantages and disadvantages Disadvantages for vendee: ⚫ vendor remains legal owner ⚫ judgments against vendor might cloud vendee’s interest ⚫ uncertainty of court decision © 2018 Rockwell Publishing Land Contracts Using a land contract Lenders generally don’t permit seller to use land contract if there is institutional secondary financing. Two possible solutions. ⚫ Vendor agrees to have property stand as security for institutional loan. ⚫ Vendee could mortgage her equitable interest in property. © 2018 Rockwell Publishing 23  Seller Financing Instructor Materials Land Contracts Using a land contract Vendor agrees to have property stand as security for institutional loan. ⚫ Vendor doesn’t assume personal responsibility for repayment. ⚫ Lender can foreclose on property but can’t sue vendor for deficiency. © 2018 Rockwell Publishing Land Contracts Using a land contract Vendee mortgages equitable interest in property. ⚫ Lender acquires vendee’s contract rights, but has to pay contract price to have title. ⚫ Few lenders find equitable interest acceptable as collateral. © 2018 Rockwell Publishing Summary Financing Unencumbered Property Institutional second Land contract Vendor Vendee Forfeiture © 2018 Rockwell Publishing 24  Chapter 13: Seller Financing Seller Financing as Primary Loan Encumbered property Seller of encumbered property generally can’t afford to offer primary financing to buyer and pay off existing mortgage at closing. ⚫ Wraparound financing is alternative. © 2018 Rockwell Publishing Encumbered Property Wraparound financing Wraparound financing: ⚫ property remains subject to underlying loan ⚫ buyer does not assume underlying loan ⚫ seller remains responsible for payments ⚫ buyer makes monthly payments to seller ⚫ seller uses part of buyer’s payment to make payment on underlying loan © 2018 Rockwell Publishing Wraparound Financing Choice of finance instrument For wraparound, seller can use: ⚫ mortgage ⚫ deed of trust ⚫ land contract Deed of trust used for wrap: all-inclusive trust deed. © 2018 Rockwell Publishing 25  Seller Financing Instructor Materials Wraparound Financing Underlying loan: no due-on-sale clause Wraparound financing only works if underlying loan doesn’t have due-on-sale clause. ⚫ Silent wrap: without lender’s consent. © 2018 Rockwell Publishing Wraparound Financing Can benefit both buyer and seller Interest rate may be: ⚫ below current market rate for financing (benefits buyer) ⚫ higher than rate on underlying loan (benefits seller) © 2018 Rockwell Publishing Summary Financing Encumbered Property Wraparound financing All-inclusive trust deed Underlying loan Silent wrap Credit extended © 2018 Rockwell Publishing 26  Chapter 13: Seller Financing Alternatives to Seller Financing Seller can help with: ⚫ buydown ⚫ contribution to closing costs ⚫ equity exchange ⚫ lease/option ⚫ lease/purchase © 2018 Rockwell Publishing Alternatives to Seller Financing Buydowns Buydown: seller pays to reduce buyer’s interest rate on loan. ⚫ Seller doesn’t tender money directly to lender. ⚫ Seller’s proceeds at closing are reduced by amount of buydown. © 2018 Rockwell Publishing Alternatives to Seller Financing Contributions to closing costs Seller sometimes willing to make up shortfall when buyer doesn’t have enough money for closing costs. ⚫ Lenders impose limits on amounts. © 2018 Rockwell Publishing 27  Seller Financing Instructor Materials Alternatives to Seller Financing Equity exchanges Seller may be willing to accept other assets from buyer and reduce cash sales price. ⚫ Equity in vacant land or personal property. © 2018 Rockwell Publishing Alternatives to Seller Financing Lease arrangements Sometimes buyer wants to lease home before actually buying it. ⚫ Needs time to save cash for closing or downpayment. ⚫ Cannot currently qualify for loan. © 2018 Rockwell Publishing Alternatives to Seller Financing Lease arrangements Seller can lease property to prospective buyer in one of two ways: ⚫ lease/option arrangement ⚫ lease/purchase arrangement © 2018 Rockwell Publishing 28  Chapter 13: Seller Financing Lease Arrangements Lease/options Lease/Option: lease agreement includes option to purchase. ⚫ Seller leases property to buyer for term. ⚫ Buyer granted option to purchase property at certain price during lease term. ⚫ Seller = Landlord/Optionor ⚫ Buyer = Tenant/Optionee © 2018 Rockwell Publishing Lease Arrangements Lease/options Lease/option: ⚫ buyer has no obligation to buy ⚫ seller can’t sell property during option period ⚫ can be used even if seller’s loan has due-on-sale clause © 2018 Rockwell Publishing Lease/Options How lease/option works Lease/option: ⚫ buyer pays seller option money to make option binding on seller ⚫ option money not refundable ⚫ option money may be applied to purchase price if buyer exercises option ⚫ rental payments may be applied to purchase (rent credit) © 2018 Rockwell Publishing 29  Seller Financing Instructor Materials Lease/Options Rental payments Rent charged on lease/option is often much higher than rent under ordinary lease. ⚫ Gives optionee incentive to exercise option quickly. ⚫ Provides compensation to optionor for uncertainty of outcome. © 2018 Rockwell Publishing Lease/Options Rent credit Two ways rent credit can be applied to purchase: ⚫ deducted from sales price ⚫ applied to downpayment Most lenders will accept rent credit as part of (not whole) downpayment. ⚫ Buyer must also invest some cash. © 2018 Rockwell Publishing Lease/Options Provisions of lease/option agreement Lease/option should: ⚫ include all terms of lease ⚫ include all terms of potential purchase contract ⚫ state that option money is not security deposit ⚫ state that option rights are forfeited if tenant defaults on lease © 2018 Rockwell Publishing 30  Chapter 13: Seller Financing Lease Arrangements Lease/purchase Lease/Purchase: purchase contract allows buyer to lease property for extended period before closing. ⚫ Parties sign purchase agreement (not option) along with lease. ⚫ Tenant/buyer provides good faith deposit instead of option money. ⚫ Closing date set quite far off; buyer rents property in meantime. © 2018 Rockwell Publishing Lease Arrangements Lease/purchase If tenant/buyer decides not to buy property, good faith deposit is forfeited. ⚫ Tenant/buyer probably more committed with lease/purchase contract than with lease/option. ⚫ Eventual sale more likely. © 2018 Rockwell Publishing Legal Responsibilities Real estate agent should: ⚫ strongly recommend both parties consult lawyers and/or CPAs, and ⚫ make recommendation in writing. Finance instruments for transaction should be prepared or reviewed by lawyer. © 2018 Rockwell Publishing 31  Seller Financing Instructor Materials Legal Responsibilities Disclosure statements Seller financing disclosure: ⚫ required in some states when agent helps arrange seller financing ⚫ discloses all financing terms ⚫ informs seller of buyer’s financial situation © 2018 Rockwell Publishing Legal Responsibilities Disclosure statements Good idea to use disclosure statement even if not required by state law. ⚫ Provides information to parties. ⚫ Protects agent by documenting that certain information was provided. © 2018 Rockwell Publishing Legal Responsibilities Buyer’s ability to repay Evaluating buyer’s ability to repay protects seller and buyer. Truth in Lending Act’s ability to repay rule: in some residential transactions, lenders and loan originators must make reasonable good faith determination that buyer can repay loan. ⚫ May apply to real estate agent in seller- financed transaction. © 2018 Rockwell Publishing 32  Chapter 13: Seller Financing Legal Responsibilities Agent’s liability Disclosure statement does not completely shield agent from liability. ⚫ Breach of fiduciary duties. ⚫ Inadvertent dual agency. © 2018 Rockwell Publishing Summary Alternatives to Seller Financing Buydown Equity exchange Contribution to closing costs Lease/option Option money Rent credit Lease/purchase © 2018 Rockwell Publishing 33