Re: Broke Rule #1… - Posted by Dave T
Posted by Dave T on November 26, 2000 at 13:12:52:
Nothing will legally compel them to immediately refinance. Instead, you give your buyers a financial incentive to refinance. If the interest rate on your note is high enough, the monthly payment itself should give the buyer an incentive to refinance.
What is high enough? Don’t know your market, and don’t know your buyer. You don’t mention what interest rate will be attached to the first and second mortgage loans. Since the property would be overleveraged, and there is apparently no equity to “secure” your third position loan, is an 18% rate enough return to offset this risk?
You ask if this is the best way to go? Again, can’t answer that without knowing more about your financial position, current cash position, and future investment plan. And I also don’t know if you wanted a comment on the structure of the deal, or, if you just wanted an opinion on an interest-only note.
That said, I do have an observation on the structure of the deal for you to consider. You said that this property is a “rehab”. I assume that your total investment in this property is well below the $105K appraisal. If this is true, then you have three income centers working for you in this deal.
For the sake of this discussion, let’s assume that your total investment (purchase and rehab cost) in this property is $75. Here’s your first income center: at settlement, you receive $30K in profit, in cash (difference between your $75K and the new $105K mortgages). Your second income center is the monthly payment you receive on your note. At 18% interest, this is $255 every month, or, $3060 each year. If your buyers take the full five years to refinance, you will have received $15300 in interest payments alone. Your third income center is the payoff on the note. When the note is satisfied, you get a $17000 payday. The numbers here illustrate a potential $62300 “profit” in five years.
Now let’s assume that the buyers run into financial difficulty and default on your note. Foreclose! If it sells at auction, you get cashed out. If you get the property back, sell it again!
Is this the best way to go? Can’t tell you. If you do this deal, will your temperment, financial position, and tolerance for risk let you sleep at night? If not, then you may want to find a buyer that will bring $17K cash to the table and avoid the third mortgage loan entirely.
One final thought for your consideration. Since this is a buy-fix-sell transaction, the entire profit on the sale of this property is fully taxable as ordinary income in the year of sale. This may put you in a position where you are paying taxes on profit you won’t actually receive until your note is cashed out. Capital gains tax rates do not apply, and, you can not use an installment sale tax treatment to defer realizing some of your profit.
Perhaps a visit with your CPA will tell you whether you can afford this deal.