Creative financing, also known as No Money Down Real Estate Investment, is an alternative means to purchase a property. Every real estate investor knows that you cannot purchase real estate with zero dollars. As such, no money down is a bit of a misnomer.
For those of you who have already purchased property using the traditional method, bank financing, are well aware of the laborious process and the requirements to obtain a mortgage. As a refresher, the four requirements that must be met to obtain a mortgage are:
- Good Credit History
- Sufficient Income to afford the mortgage payments
- Low Debt / Income Ratio
- Significant Down Payment
Many willing buyers cannot meet the requirements for a variety of reasons. Does that suggest that these buyers are shut out of the real estate market? Not necessarily. There are four methods that you can use to purchase real estate which does not require bank financing.
I will review each method and the circumstances to which they are best suited. Before we begin, it is important to note that these methods only work with about 5% of sellers. Most sellers will utilize a real estate broker to facilitate the sale of their property.
This 5 % of sellers are usually distressed sellers. They either cannot afford the services of a real estate broker, or they are looking for a fast sale. Most of these sellers will either try to sell the property themselves or they will attempt to rent the property in order to cover the mortgage payments.
How do you find those sellers? The simplest way to find them is to drive through a neighborhood and look for either For Sale By Owner or For Rent signs. It is then just a matter of calling them and determining what their situation is.
Since the market crash and the onset of ZIRP (Zero Interest Rate Policy) implemented by the Federal Reserve, investors have been looking for better returns on their investments.
Another group has also joined the fray, namely, retirees. They own their homes free and clear. They may be looking to downsize or move to rental accommodations where they are no longer burdened by maintenance and upkeep. These sellers are ideal candidates for seller financing.
Seller financing rates are usually 1 – 2% higher than bank mortgage rates but you save on the appraisal fees and origination fees. In addition, the banks will most likely charge a higher interest rate if the home is not owner-occupied.
If the seller agrees to finance the sale, he can often command a higher sales price, and as an added bonus, gets a higher rate of return than he would receive from a savings or money market account.
The majority of distressed sellers consists of sellers losing their job, going through a divorce, or a medical emergency which necessitates the sale of their home. Usually, the home is highly financed with little equity in the property. As such they cannot afford the services of a realtor.
For example, a home has a market value of $150,000, but the seller has a first mortgage of $140,000. Realtors charge a commission of 6% and there are closing costs for the seller that can range from 1-3% of the sale price. That is potentially 9% of the sales price. In this example that amounts to $13,500 which is less than the equity of $10,000.
Furthermore, there may be some repairs that are required that the seller cannot afford, which would result in an even lower sales price. Their only option is to try to sell the property on their own, as is.
The documents pertaining to a home consist of the deed, which shows proof of ownership, and the mortgage which shows how much financing is registered against the property.
You, as the buyer, can offer to take over the existing mortgage payments and have the seller sign over the deed. The mortgage remains as is.
Due on Sale Clause
Many lenders include a clause known as a Due On Sale clause in their mortgage documents. This means that if the property is sold and the deed is transferred, the mortgage is automatically due and payable. However, in practice, this is rarely an issue. As long as the lender receives the monthly payment on time, no action will be taken.
Prior to closing the deal, it is important to have an attorney or title company do a title search to determine that there are no other liens registered against the property. If there are liens, they would have to be satisfied at the time you actually sold the property to a third party.
Another popular method of creative financing is the Lease Option Agreement. In this scenario, the buyer agrees to rent the property for a specified period of time. Included in the lease agreement is a clause that allows the buyer to purchase the property at any time during the period of the lease agreement for a specified price.
This method of financing is ideal for the investor who wishes to purchase a property, renovate, and then resell the property. See my post BRRR Strategy. The cash that would have been used for the down payment can be used to cover the cost of the renovations.
Once the renovations are complete, the property should appraise for a higher value. The tenant can then exercise his option, and obtain a traditional mortgage equal to the amount of the purchase price agreed upon in the lease option agreement.
For an example of a lease option agreement go here.
A Lease Option is ideal for a seller who has accepted a job transfer and needs to move quickly. The wording of the lease option agreement is critical. Again, hire an attorney or title company to do a title search and confirm that no liens other than the mortgage are registered against the property.
Your attorney should also insert a clause that holds the seller liable for any other liens that may be registered against the property from the date of commencement of the lease. This would not include liens resulting from renovation work done by you.
Hard money is essentially a mortgage obtained from a private lender. If you as an investor negotiate a deal on the purchase of a property where the purchase price is 15 – 20% less than market value, a private lender will loan you the entire purchase price amount.
All you need is a current appraisal of the property. You can receive the cash in a matter of days. The downside to this method is that you will pay a significantly higher interest rate than what you would pay on a traditional bank mortgage.
This type of financing is ideal for an investor who is looking to renovate and flip the property in a short period of time. Even though the rate is higher, you forgo the approval process and you save 0.5 – 1.0% of the loan in origination fees. A hard money loan can get you the cash you need when time is a critical factor.
If you are new to the real estate market, and you do not have sufficient savings to buy a property using traditional methods, one of these creative financing options might open the door for you. Seasoned real estate investors use these methods regularly.
Do not be afraid to approach a seller with any of these options. The worst thing that can happen is that they will reject your offer. If so, move on to the next opportunity. Good luck!
This information is provided for educational purposes only and is not to be construed as professional advice. Please consult with a real estate attorney for any legal questions. Consult a tax accountant for any tax-related issues that you might have. If you are unfamiliar with other forms of investment, consult with a financial adviser. Every situation is unique and may require specialized advice.