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1. Exchanging Equity in a Home for Equity in
Income-Producing Property
This strategy is designed to help you buy a champagne
home on a beer income at no increased out-of-pocket
costs. It involves exchanging equity in an old residence
for equity in an income-producing property that
generates sufficient revenue both to make payments on a
more expensive home and to repay any loan.
The Strategy
Let's say you already own a house, but you want a
better, more expensive home. Unfortunately, you find
that your income is not sufficient to cover the
increased payments. Your credit is good, however, and
you have 30- to 50-percent equity in your current
property—meaning that you still have to pay off a
mortgage on 70 to 50 percent of the property.
Go to your banker and borrow the down payment for the
desired house. The monthly mortgage payment on your new
home will be higher than your current mortgage payment,
so figure out how much more money you will need per
month to make the new payment. Then exchange the equity
in your current house for the down payment on an
apartment house that generates enough spendable income
to cover the difference between your present monthly
mortgage payments and your new house payments, and
repay the bank loan.
You will now have the home that you want. Moreover, you
will have a depreciation allowance on the
apartment house—an amount that you can deduct from your
yearly taxable income based on the perceived loss of
value due to the property's increasing age and resulting
wear and tear. This allowance will lower your ordinary
income tax on the revenue received from the property.
A Scenario
A realtor friend of mine had a client who owned a home
appraised at $100,000. He owed $50,000 on the first
mortgage, payable at $450 per month. The client and his
family wanted a larger home in a better area, and really
liked a house that was selling for $200,000. But when
they examined their budget, they found that they were
unable to squeeze out enough to make the additional $600
monthly payment it would take to get the new residence.
They visited the house several times and after a month,
when no one else had bought it, they went to the realtor
with open minds.
The client was willing to do anything legal and
reasonable to get that house. The realtor determined
that the man's credit was spotless, verified his income
and job security, and discussed with the sellers the
possibility of a contract sale. The realtor then
returned to the client and laid out his plan, which was
accepted.
The next day, the client met the realtor at the bank,
where they negotiated a $25,000 loan. The broker
presented the $25,000 check to the sellers as a deposit
for the down payment on the house. The broker agreed to
accept his fee from the monthly house payments that
would be made to the seller, who would carry back the
note on the mortgage loan.
Next, the realtor took the $50,000 equity in the
$100,000 house that his clients wanted to vacate, and
contacted a builder who had a twelve-unit apartment
house. The realtor used the equity in the house as a
down payment on the apartment building, which—after
expenses and mortgage payments—would show a spendable
income of $1,100 a month. Again, the broker would take
his fee out of the monthly payments his clients would be
making to the builder, who would carry back the note.
The spendable income of $1,100 a month, plus the savings
in nontaxed income from the apartments due to the
depreciation allowance and interest deductions, was
enough to let the family live comfortably in their new
$200,000 house. It should be noted, though, that to keep
the spendable cash flowing, the client had to manage the
apartment house himself, perform some of the
maintenance, clean the laundry room, and mow the lawn.
That's why this strategy requires a buyer who is
confident in his ability to perform all the functions
necessary to make the arrangement work.
Understanding Owner Financing
It goes by many names—owner financing, seller
financing, seller carry-back, vendor
take-back mortgage, and mortgage back—but no
matter what you call it, this technique is important for
anyone involved in real estate, from a first-time
homebuyer to a savvy real estate investor. The concept
is simple. The seller of the property agrees to finance
part or all of a real estate transaction by lending
money to the buyer. In essence, the property owner
assumes the role of the banker, and carries back the
loan in the form of a note. As in any other sale, a down
payment (if any) is negotiated between the seller and
the buyer, and the buyer sends regular payments to the
seller, typically on a monthly basis. About 20 percent
of the houses sold in the United States involve some
form of owner financing.
Owner financing is most often used when the buyer has
difficulty qualifying for a conventional loan, such as a
bank loan; when conventional financing is too expensive;
or when the existing first mortgage may be assumed by
the buyer, but the difference between the existing debt
and sales price exceeds the resources of the buyer. In
commercial lending, the borrower typically locates
lending programs with rigid preset provisions, and
applies for the most desirable set of terms. But owner
financing is truly flexible, allowing the property owner
and buyer to negotiate the down payment, if any; the
interest rate; interest and payment adjustments, if any;
balloon, payment dates, if any; any acceleration
clause—a provision giving the seller the right to
declare the entire loan balance immediately due; and
other provisions that a buyer would find it difficult to
negotiate with a conventional lender. As long as the
buyer and seller agree, the down payment can be skipped,
or low monthly payments can be made until some future
time, when the buyer is able to increase payment size or
pay the loan off in full. Owner financing even allows
for the inclusion of unusual terms in the note. For
example, a payment may be set for the twenty-first, of
the month because the purchaser will use a paycheck from
the sixteenth to make the loan payment. Or, if the buyer
is a farmer, payments can be arranged to coincide with
yearly crop sales.
Owner financing saves costs for both the property owner
and the property buyer. It benefits the buyer by
eliminating nearly all origination fees, thus saving
from 2 to 5 percent of the total loan price. How does
the seller benefit? By spreading the owner's capital
gains over time, rather than giving him the lump sum he
would receive from a conventionally financed mortgage,
owner financing can sometimes prevent the seller from
being bumped into a higher tax bracket, or can create
time to take some capital losses as a means of
offsetting gains. This technique further benefits the
seller by providing good interest earnings. Although
completely flexible, owner financing rates are typically
higher than conventional home loan rates, and 4 to 5
percent higher than the rates offered by money market
accounts.
Finally, owner financing benefits both parties by moving
much more quickly than conventional financing, which can
take a month or more. The owner-financed transaction can
close as soon as the seller and buyer can agree on its
terms.
While all of these benefits are important, you will
probably find owner financing most appealing because its
flexibility makes so many great investments possible.
Within this book, Strategies 1, 40, 9 and 41—to name
just a few—show just how versatile this investment tool
can be. As you learn more about it, you'll discover that
owner financing can truly help you finance almost any
real estate, any place, any time. |
