Trust Deed Financing

Perhaps the lender won't allow an assumption or the seller owns the property free and clear.

Maybe the property has deferred maintenance or a high vacancy rate and the banks will not finance it. If there is no loan, the seller can play banker and use a trust deed to create a transaction whereby the buyer makes a lower down payment and the seller sets more flexible terms. Again, the benefits here are lower transaction costs and the opportunity for the seller to reduce interest costs. The seller can write a trust deed for any number of years and at whatever terms work for both parties. The seller might also take back a note and then cash out by selling the note.

Contract Financing (The Wrap)

If there is a loan in place, the seller can still carry a note by "wrapping" a new loan around the existing mortgage. In most loans or contracts you may have to ask the existing loan-holder for permission to assume the loan. In particular, you need to look very closely at the "due on sale" language (the "acceleration" clause) to see if it is possible to have wrap financing.

With wrap financing, the original, low-interest loan stays in place and new financing from the seller or a third-party is added on. Here's a model showing how a wrap loan might work:

Purchase Price: $ 1,000,000
Amount down: $ 100,000
Existing Loan Balance: $ 500,000 at 7 percent
Then-Current Commercial Interest Rate: 9 percent.
Wrap Loan: $ 900,000 at 8 percent.

In this example, the original loan stays in place and the owner takes back an additional $ 400,000 ($ 900,000 less $ 500,000). But the owner is collecting 8 percent interest on $ 900,000 -- this includes 8 percent interest on $ 400,000 and 1 percent interest on the original $ 500,000 mortgage (8 percent less the original interest rate, 7 percent). Run the numbers and you'll see that the owner is collecting far more than 8 percent on his or her investment because the original $ 500,000 belongs to another lender.

I would only recommend wrap financing if you have some extra money in standby reserve to buy a new loan in case the existing one is called. Also, make certain payments are made to the original lender by using a third-party contract collection company, thus protecting both the buyer's and seller's interests.

Short-Term Financing

Judy Buyer wants to buy a 5000 sq. ft. commercial building. Max Seller owns the building free and clear and wants to sell it in order to buy a new boat. Max thinks his building is worth $ 350,000, but the boat and the summer on the lake are beckoning, so he agrees to sell for $ 300,000 to close right away. Judy has $ 50,000 to use as a down payment. Max agrees but then Judy realizes that she cannot get financing because the building has no tenant. Max has his attorney draft up a trust deed for one year, so that she can get into the building, find a tenant, and then refinance it. He can make a down payment on the boat now and pay it off in a year. They deal closes and they both are happy.

Of course, if he had wanted to complete a tax deferred 1031 exchange, this would not have worked, but Max was willing to pay his taxes and Judy agreed to pay him 10% interest for the year and then pay him off in full.

There are risks involved when sellers play banker and buyers use creative financing, but if each party engages a good attorney and tax professional to draft the documents, everyone should be in good shape and the deal will get done.

Copyright 2001 Clifford Hockley. Posted by Realty Times with permission.