Archive for November, 2010

Creative Financing

November 29th, 2010

I entered into my first real estate contract in 1971.  There was nothing creative about it.  A man wanted to sell two acres in the mountains and he was offering seller financing.  We agreed upon a $20,000 sale price:  10% down, 10% interest, a 10 year amortization, which was $237.87 or more per month until paid in full.  That is a very straight forward contract.  In my 35 years of dealing with real estate contracts most of them fall within this category.  Although, after reviewing thousands of contracts, there is a small minority of these seller financing instruments that fall under the umbrella of “creative financing”.  Let’s start with the down payment.

Most down payments in real estate contracts are cash.  But, I have seen down payments given as horses, saddles, horse trailers, cattle, trucks, cars, appliances, tools and tractors.  I have also seen services as a down payment.  For example:  “the $10,000 down payment is to be the replacement of the roof of the seller’s mother’s house by the buyer.”  I have also seen where a piece of property is deeded to the seller as all or part of the down payment.  And my favorite is when the buyer is a New Mexico Real Estate broker buying for his own profit and portfolio and his commission, which is paid by the seller, will constitute the buyers down payment.  Here’s where I’m supposed to caution you to have the buyer and seller consult an accountant as to the tax consequence of accepting personal and real property as all or part of the down payment.  I also want to point out that when evaluating these down payments, one man’s trash is perhaps another man’s treasure.  That’s to say if the buyer doesn’t value this down payment he’s more likely to walk than someone who put down cash.  Now, terms.

Most contracts have a fixed interest rate, although it’s not unheard of for the parties to peg the interest rate to an index.  This is the same concept as an adjustable rate mortgage.  For instance, “the interest rate will adjust annually from the date of the contract two points above Wall Street Prime”.  Here’s where you have to decide whether the payment will be adjusted at that point in time to stay on track with the original amortization period or if the payment stays the same and the amortization period changes.  This could possibly create a negatively amortizing contract.  In either case, the contract should be due in full, plus accrued interest, no longer than 30 years of the date of the contract.  Next would be payment periods.

They can be monthly, semi-annually, annually, interest only, and a whole dozen more.  You can also have monthly payments, with interspersed principal reduction payments (balloon payments).  You can get as creative as you want.  I once owned a real estate contract on a 29 acre alfalfa farm in Jarales, New Mexico.  The payment schedule was something like this:  “Buyer is to pay $5000 or more which includes 10% interest within 30 days of any alfalfa cutting.  There’s to be a minimum of two payments per year.”   So, some years I received $10,000 and other years I received $20,000.  As you can see, you can get as creative or crazy as you want.

As the owner of an escrow company, I have to tell you that the straightforward contracts with 7% or more cash down tend to be less problematic.  The more creative the buyers and sellers get, the more verbiage it requires.  More verbiage lends itself to more and diverse interpretation in the future, including the escrow company.  I’m not discouraging creative selling of property.  I am encouraging that the buyers and sellers are absolutely certain of the intent and understand the language.  Keep in mind 30 years from now it might not be the original parties dealing with this, but the heirs or trustee.  Every thing is open to interpretation and dispute.  For instance, if I say to my wife, “Am I correct in assuming that we need to turn left up here?”  Her response, of course is, “right”.