Creating Financing

The information provided on is not intended to be legal advice; it merely conveys general information related to legal issues commonly encountered in real estate sales.  If you want to know the impact of this information on your particular situation, please consult with an attorney. 

Whether we are talking about loan wraps (selling to a buyer without paying off the owner’s mortgage), lease options (option agreements), lease to purchase arrangements (leases with a contractual right to purchase the property) or, perhaps, straight rental agreements, these alternatives for relieving a property owner of the burden of a mortgage when buyers are scarce carry risks.

Deeds of trust in this day and age have very restrictive “due on sale” clauses which prohibit property owners from transferring ownership or control of all or a part of the owner’s interest in a property to another. These due-on-sale restrictions likely prohibit the owner’s alternatives for mortgage relief.  Therefore, any property owner considering these financing alternatives should review his or her deed of trust for due-on-sale restrictions and consult with the trust holder and/or an attorney to determine what alternatives may be available.
 
An owner who violates his or her due-on-sale clause may well be giving the trust deed holder (the lender) the right to accelerate the loan, i.e. the right to call the loan immediately due and payable in full.  If this happens, the seller must pay the full amount of the loan within a short period of time or face foreclosure proceedings.  If the lender calls the loan, where will the owner get the money to pay it?  The owner probably can’t re-finance his or her loan either because he/she has transferred an interest in the property to the buyer or because in today’s tight credit market, financing is not available.  The owner very likely cannot get it from the buyer because the buyer likely needed alternative financing in the first place because of an inability to get a direct loan. 
 
My clients often assert the fact that there is no due-on-sale jail, i.e., it is better to ask for forgiveness and not permission.  Although the risk of criminal prosecution exists for those who commit loan fraud, it is true that, for buyers and owners, the risk is more likely to be monetary than criminal. 

In addition to the lender calling the loan, the risks of financing alternatives to property owners include:

• For lease options, lease to purchase and, straight lease arrangements, the seller will be a landlord during the lease period with all of the obligations attendant to that role, including compliance with Oregon’s Landlord-Tenant laws.  The landlord may have to evict the tenant, make major repairs (to provide a habitable space) or deal with the damages inherent in the rental of property.  Also, if the parties have agreed that the buyer will make all repairs during the lease period as though he or she were an owner, the seller risks that the buyer will make repairs without governmental permits, use self-help on repairs (and be incompetent) or hire incompetent help.
• For owners who are leasing/renting the family home, the owner may be giving up an exemption to capital gains tax.  The owner will also have to declare rent as income.  Property owners considering financing alternatives should consult with their own tax professional for advice on the tax ramifications.
• Only 7% of these transactions close.  The buyer, given that he or she is likely a marginal credit risk, may (i) lose interest in buying the property, (ii) suffer a change in family circumstances; or (iii) discover that he/she will not be able to secure financing when the time comes to purchase the property.  If this happens, the Landlord will still have the house with all of the additional problems inherent in selling a rental property.  Also, if the buyer abandons the property, the buyer’s right to purchase the property may well remain, resulting in a cloud on the title and preventing the seller from selling the house until the purchase right expires or a court vitiates it.

The risks of financing alternatives to buyers are: 

• Only 7% of these transactions close.   In a static or declining market (where prices are not increasing) in which credit may remain difficult to obtain, the buyer has little, if any, incentive to lock up a purchase price on a property this way. 
• Option money and/or increased rent money intended for a down payment may be nonrefundable and, even if the money is refundable, the property owner may have spent the money and have no ability to repay it. 
• Loan wraps, lease to purchase and lease options are usually not recorded, allowing the property owner to further encumber the property through lines of credit or by way of judgment liens for unpaid credit card bills, child support, etc. such that the owner will be unable to convey clear title when the buyer is ready to finance his or her purchase.
• The owner may stop making mortgage payments such that the lender institutes foreclosure proceedings.  In that case, the buyer will be evicted and his or her only remedy against the owner will be in court.  Since the seller stopped making mortgage payments, it seems unlikely that the seller will have money available to pay the buyer even if a court says the owner must do so.

The bottom line is that any owner or buyer considering alternative financing arrangements should get competent legal advice to protect him or herself from the risks inherent in creative financing arrangements. 

 

 

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