REAL ESTATE ARTICLES

ALTERNATIVE AND CREATIVE FINANCING

By: Roman P. Mosqueda, Esq.

Real Estate Broker and Attorney

In these times of unsteady economy and fluctuating interest rates, alternative and creative ways of financing are answering the changing needs of borrowers for credit to buy or refinance homes in a rapidly changing marketplace.

Indeed, a purchase money loan secured by a first deed of trust may not be sufficient to close the sale. A secondary loan secured by a junior trust deed may be needed to complete the purchase, and acquired by seller financing (“seller carries back”) or from another source, such as a mortgage banker or private investor.

Or a buyer can convince a co-buyer to contribute to the downpayment of the purchase of a property to be held as a co-ownership (tenancy in common) or in joint tenancy with right of survivorship.

Or the property may be purchased in the name of another person with better credit, but held in trust for the “beneficial” owner who pays the loan and occupies the property. Execution of a declaration of trust is recommended for such an arrangement.

This article discusses various methods of alternative and creative financing in purchasing real property because there is no single type of financing that fits everyone.

Seller Financing:

A common method of secondary financing for the purchase of real property is seller financing, in which the seller acts as a lender and agrees to “carry back” a certain amount of the purchase price.

Such a “carry back” loan is a purchase money loan that can be secured by a junior second trust deed, next in line to the first trust deed securing the first loan on the property.

A seller may be motivated to “carry back,” to reduce tax liability by accepting installment payments, in case he or she receives a substantial amount from the proceeds of the buyer’s first loan and from the buyer’s down payment.

Or the seller may want income (principal plus interest) from the secondary loan to the buyer, secured by the property he or she is selling, with knowledge of the value thereof.

And a seller who “carries back” may sell his second trust deed to a mortgage broker, who discounts the note and junior trust deed, and pays cash to the seller before the maturity of the loan.

Seller Financing

Disclosure Statement:

When the purchase of a residential property includes an extension of credit by the seller, a Seller Financing Disclosure Statement is required by Section 2956 of the California Civil Code.

It is a two-page disclosure statement from the purchaser (buyer) and vendor (seller), prepared by an arranger of credit (a person either a party or not to the credit transaction or a real estate agent, who is involved in developing or negotiating credit terms, participates in completion of credit documents, and receives compensation for it).

It states the type of credit documents: whether note and deed of trust, all-inclusive note and deed of trust, installment land sale contract, lease/option (when parties intend transfer of equitable title), or any other type.

It also states the terms of credit, prepayment penalty if any, due on sale, and other terms, as well as, information on existing loans or encumbrances on the property.

It further states the representations concerning the buyer’s credit worthiness as to occupation, employer, length of employment, monthly gross income, credit report, and loan application.

It provides the seller and the buyer with relevant information in deciding whether or not to utilize seller financing.

Wrap-around Loan Or

All-Inclusive Trust Deed

(AITD):

Another alternative and creative type of financing is a wrap-around loan, also known as all-inclusive trust deed (AITD).

Simply put, this type of financing or loan wraps an existing loan(s) or encumbrance(s) with a new loan, and the buyer-borrower makes one payment for all loans, new and old ones.

The new loan is secured by an all-inclusive trust deed (AITD), which is junior or subordinate to an existing deed(s) of trust or encumbrance(s) on the property, which are included or wrapped in the AITD.

So, instead of a buyer assuming an existing loan and the seller carrying back a second trust deed, in the AITD, the seller becomes a new lender, continues paying the existing loan(s), and provides the buyer with a new increased loan with higher rate of interest.

Thus, the amount secured by the AITD includes the balance on the principal of the existing or underlying loan(s) plus the amount of the new loan being extended by the seller.

The borrower pays the seller for the new loan at a higher rate of interest than the existing loan; while the seller continues paying the existing loan and keeps the difference.

Limitations Of

AITD:

Although the seller usually gets a full-price offer from the buyer, who is attracted by the AITD financing features of low down payment and absence of loan qualification and fees, it requires the following:

(a) a seller who does not need to cash out;

(b) approval by the underlying or existing lender of the AITD financing to avoid the effect of the due-on-sale clause (the principal balance paid on the sale of the property) of the existing loan;

(d) a neutral, third party who collects from the buyer and pays the underlying or existing loan(s) and forwards the difference to the seller.

Indeed, if the seller receives payment from the buyer, and in turn, does not pay the existing lender, foreclosure of the property would follow, even if the buyer has received title to the property at closing of the sale or escrow.

Although there are greater benefits to both seller and buyer in an AITD loan, there are also risk of foreclosure and added cost involved in this “creative” financing.

The following illustration shows how an AITD loan financing works:

- Purchase Price of Home: …………………………. $600,000.00

- Cash Down Payment (15%) By Buyer:…………… $ 90,000.00

- AITD loan By Seller: …………………………….$ 510,000.00

- Monthly Payments on AITD of $510,000 at 7%

Interest to Seller:………………………… $ 2,975.00

- Monthly payments on existing First Trust Deed of

$400,000 at 4% Interest to be paid by Seller: … $ 1,333.34

- Monthly difference to Seller:……………………… $ 1,641.66

Other Types Of Financing

Or Loans:

A. Contract Of Sale Or

Installment Sales Contract:

In this type of financing, the seller keeps title or legal ownership of the property until the loan is paid off by final installment payment.

Section 2985 of the California Civil Code defines a real property sales contract as “an agreement wherein one party (seller) agrees to convey title to real property to another (buyer) upon the satisfaction of specified conditions (usually when the loan is paid off) in the contract and which does not require conveyance of title within one year from the date of formation of the contract.”

The buyer may possess and use the property under an equitable title, although legal title is retained by the seller.

B. Reverse Mortgage:

In this type of financing known as reverse mortgage, a homeowner is extended fixed monthly cash advances based on the built-up equity on, or the value of the borrower’s owner-occupied principal residence.

Under Section 1923(b) of the California Civil Code, “the loan requires no payment of principal or interest until the entire loan becomes due and payable,” upon the occurrence of any of the following events, stated in Section 1923.2(f) of the same Code:

“1. the home securing the loan is sold or title (thereto) … is otherwise transferred;

2. all borrowers cease occupying the home as a principal residence;

3. any fixed maturity date agreed to by the lender and the borrower occurs; or

4. an event occurs which is specified in the loan documents and which jeopardizes the lender’s security.”:

Alternative financing can be as creative as consenting lender, borrower and sometimes, third-party would like it to be, limited only by the constraints of public policy in the Civil Code discussed above.

(The Author, Roman P. Mosqueda, a real estate broker and attorney, can assist buyers-borrowers with alternative and creative financing.)