Archive for the ‘ Information ’ Category

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”.

Enhancing Profit Made On Real Property

October 18th, 2010

Wrap around real estate contracts (RECs) can enhance the profit made on real property. There are literally dozens of different ways to use a wrap around REC. Here’s just one example.

Carmen purchased a piece of vacant land a couple of years ago. She bought it from Robert on an assumable REC. Today she owes Robert $100,000 at $1,000 per month at 8% for the next 166 months. Jim shows up and just has to have her property. He offers Carmen $130,000 for the property. Jim wants to give Carmen $30,000 down and assume the $100,000 REC that she is paying Robert on. Carmen doesn’t want the $30,000 cash for two reasons. First, she would have to pay capital gains tax on her profit now. By using seller financing she can spread her capital gains tax out over the life of the contract. Secondly, she doesn’t have a better place to invest her money. So, Carmen and Jim agree that they will enter into a REC where Jim puts down $10,000 and will pay the remaining balance of $120,000 to her under the following terms: $1,337.23 per month at 10% interest for the next 166 months. Carmen is leaving $20,000 of her equity in the transaction. Carmen promises, under this contract, that she will have Robert paid off before or at the same time that Jim pays her off.

Here’s the mechanics: Every month Jim sends $1,337.23 to the escrow company, as per his and Carmen’s contract. Carmen has instructed the escrow company to send the entire $1,337.23 she receives from Jim to Robert on her behalf. By doing this Carmen will have Robert paid off in 104 months instead of 166 months. Then, Carmen no longer owes Robert, but Jim will still owe Carmen $64,500 at the end of the 104 months or $1,337.23 for another 62 months. The most important thing to remember when structuring a wrap around real estate contract is to make sure the wrap around contract does not amortize faster than the underlying obligation which it pays.

Carmen turned $20,000 into $64,500 in just 8.6 years. If Jim makes a lump sum payoff of $64,500 on the 104th month, Carmen’s return on her $20,000 is about 13%. Now, that’s a wrap.

Title Insurance

August 24th, 2010

The other day someone said to me, “I don’t need title insurance if I’m buying property on a real estate contract, do I?” What I wanted to say was, “You don’t need a parachute to jump out of an airplane either, but it’s better to be safe than sorry.” Whether you buy real estate by paying cash, trading, taking out a loan or utilizing seller financing, you should always get title insurance. Murphy’s Law is real. It is true that prior to about 1985 the sellers on real estate contracts wouldn’t give the buyer a title policy until the contract was paid off. This used to be the language:

It is understood and agreed upon the completion of all the stipulations and agreements herein contained, said Owner will, at the time of delivery of Warranty Deed, also deliver to said Purchaser, abstract of title or title insurance, showing said real estate to be of good and merchantable title on the date of the delivery of the Warranty Deed.

This wording caused all kinds of problems like, Where’s the seller 25 years later? Who’s supposed to squeeze the money out of the seller for the title policy? Were there any liens on the property? Were there any Title Defects?

Here is the currently accepted language:

Title Insurance of Abstract-Seller is delivering a Contract Purchaser’s Title Insurance Policy to Buyer or Abstract of Title to Escrow Agent at the time this Contract is escrowed, showing merchantable or marketable title to the Property as of the Effective Date, subject to the Permitted Exceptions, and Seller is not obligated to provide other evidence of title.

But, how can the sellers give a policy when they are not giving legal title until the contract is paid off? The buyer only has equitable title until then. Good question. I wish I’d thought of it.

Here’s what an attorney told me and you should ask your own attorney. There is this thing-a-ma-jig called the “Relation Back” doctrine.

Since the early common law, when necessary to prevent frustration of the intention of the parties to an escrow, the courts have indulged in the fiction that the second delivery from escrow “relates back” in time to the first delivery into escrow, and is given effect from the time of the first delivery… The doctrine has been invoked to validate a second delivery occurring after the death of the grantor or after the grantor becomes insane or is otherwise legally incapable of making a deed. Also, voluntary conveyances of title by the grantor to other parties after delivering a deed into escrow are of no effect, and judgment liens attaching to the grantor’s interest after the first delivery into escrow are cut off by the second delivery from escrow… In short, as a general rule, after the first delivery into escrow, there is nothing that either the seller or buyer can do, voluntarily or involuntarily, to defeat the title conveyed by the second delivery from escrow… the only exceptions are federal tax liens attaching to the buyer’s interest in the property and in New Mexico, mechanics’ liens attaching to the buyer’s interest when the seller had knowledge of the improvements being made to the property, but failed to post a notice of non-responsibility on the property within three days after learning of the work. Both of these liens survive the second delivery from escrow by virtue of statutory law. The IRS lien can also be released with proper notice.

(I actually lifted this explanation out of Larry Buchmiller’s book, Real Estate Contracts in New Mexico. It’s okay—I own the publishing rights.)

So, you see the title policy is effective to the date of the Real Estate Contract and not when the contract is paid off. A title policy will insure you against any defect in title or any unfound recorded claims or liens on the property.

How do I handle an offer that uses Seller Financing?

August 24th, 2010

I often hear the following comment, or something like it, from fellow REALTORS® throughout the state: “I know how to prepare a purchase agreement on a property that requires conventional, FHA or VA financing, but I’m not sure how to properly handle an offer that uses seller financing; nor do I know the sequence of events after the offer is accepted”. Let me try to address this in 300 words or less.

Most, if not all, RANM Purchase Agreements have a section that pertains to financing. Seller financing is included in this section. Fill out the purchase agreement just as you normally would and check seller financing. Now you need to fill out and attach RANM Form 2402 (Addendum to Purchase Agreement-Real Estate Contract). This is a”mini me” of a Real Estate Contract (REC). The title company and their attorney need this information to correctly prepare the REC and deeds.

Some REALTORS® choose not to use RANM Form 2402, but instead try to cover the terms of the transaction on a blank Addendum Form. This practice leads to a lengthier closing period and leaves the REALTOR® vulnerable to a future law suit. RANM provides these forms for a purpose. Please use them. After the purchase agreement has been signed and accepted, take it to the title company. The title company will then order a title binder. Once that is completed, they will send it with your purchase agreement and the addendum to the attorney who prepares the REC and deeds. The attorney then sends the documents back to the title company. Now, you close. Buyer and seller sign the REC and deeds. The REC is recorded and sent to the escrow company along with the unrecorded deeds. The escrow company now “sets up” the account. They send out a welcome letter, general information, and an amortization schedule to both parties. The buyer will be sent payment coupons. Once the buyer has paid off the REC, the escrow company will send the buyer the warranty deed that it has been holding. Like anything else, it’s pretty easy once you know it.

Who owns the property when a New Mexico real estate contract is used in a seller financed transaction?

July 14th, 2010

Real estate contracts (REC) are used in about 95% of all seller financed sales. A REC is a legally enforceable agreement by which a seller agrees to sell, and a buyer agrees to buy the property on a deferred payment arrangement. If the buyer performs all his obligations under the contract, he is entitled to receive a deed from escrow conveying the legal title to him. The seller and buyer jointly appoint a neutral third party as escrow agent to hold documents, collect and disburse payments, maintain a payment ledger and deliver the documents upon payoff or forfeiture as instructed. If the buyer defaults, the seller has the option to either (1) declare a forfeiture of the buyer’s interest in the property without court action and recover a deed from escrow conveying the buyer’s equitable interest to the seller, or (2) declare the entire unpaid balance of the purchase price to be due and payable, and file suit to collect.

The real estate contract does not transfer legal title to real estate. Instead, it obligates the seller to transfer the legal title to the buyer upon the happening of some future event. The transfer of legal title is always done by a separate deed of conveyance, usually a warranty deed, which is placed in escrow when the REC is signed.

The REC does, however, transfer an interest to the buyer, known as “equitable title”. If the buyer defaults on the performance of his contract obligations and the seller elects to terminate the contract, it is essential that the seller recover this equitable property interest from the buyer, in order to have clear title to the property. For that reason, the buyer signs a special warranty deed which is placed in escrow together with the sellers warranty deed to the buyer.

The buyer gets the use of the property. They benefit from any appreciation. They also get to deduct the property taxes and interest they pay on their income tax return. The seller must report any interest they receive to the IRS.