In Part 1 of The Easy Way to Get Low Down, Low Interest Loans, I explained that there are many homes today that have little equity that are subject to low interest loans that can be assumed. Even though these loans will almost always have a “Due on Sale” clause, the risk of a Lender invoking that clause today is extremely low.
If the Seller’s equity is small (say 10% or less of the sales price) the simple way to structure such a sale is to have the Buyer pay cash (or exchange something) for the Seller’s equity and just assume the loan. However, it is important to remember that in the highly unlikely event that the Lender calls the loan, the Seller remains liable to the Lender and will be named in the foreclosure action and could be liable for a deficiency if the Lender pursued a judicial foreclosure (a fairly rare event in most states—and particularly so in Alaska). Even if the Buyer signed a full assumption agreement and agreed to hold the Seller harmless, there would be no defense against the Lender, just a right to sue the Buyer for damages. If the Seller was experiencing financial difficulty and was likely to lose the home through foreclosure any way, this may not be an issue.
In other cases where the Seller is concerned about protecting credit standing and has a concern about liability to the Lender, the way to structure the sale is to have the Buyer give back a “0 Balance Wrap Around” to the Seller, in which the Buyer makes payments to the Seller and the Seller then pays the Lender from the payments received from the Buyer. This way, if the Buyer defaults the Seller can foreclose and continue to make the payments to the Lender until the foreclosure is completed and the property is resold. In spite of the name “0 Balance Wrap Around”, I always recommend that the balance on the Wrap Around be at least $1,000 greater than the amount owed to the Lender with an interest rate at least 1/8th percent greater and payments $25 per month greater than the amounts due to the Lender. By doing this, there is no danger of the Wrap Around amortizing before the underlying loan being paid to the Lender and there will be enough excess in payments to cover the administrative cost of establishing a collection escrow to administer the Wrap Around.
In cases, where the Seller’s equity exceeds the Buyer’s ability to cash it out, a Wrap Around is also a better way to pay for the Seller’s equity than giving back a 2nd Note to the Seller. The spread between the payment made by the Buyer and the payment made to the Lender, provides an amortization of the Seller’s equity. In cases where the cash down payment is not enough to pay a real estate commission and meet the Seller’s cash needs, all/or part of the payments being received on the Seller’s equity, can be assigned to the real estate licensee as a deferred real estate commission.
One reason that more sales aren’t being made using assumptions is that some real estate companies have a policy against allowing their licensees to participate in such sales as a result of lawsuits in better times when Lenders were invoking the “Due on Sale” clause. I believe that real estate companies would be wise to re-examine their policies in light of today’s real estate environment. Also, one of the best defenses against lawsuits from Buyers and Sellers is making certain that all parties are fully informed about all the facts and risks involved and have signed a statement acknowledging receipt of the disclosure. I believe that each company should use a written disclosure prepared by their own attorney.
When properly structured, and with full and honest disclosure to all parties of risks created by “Due on Sale” clauses, sales involving Assumption of Existing Loans are truly The Easy Way to Get Low Down, Low Interest Loans. If you are not using the time proven Creative Financing technique, you are missing out on one of today’s best methods of financing real estate sales!