Speaking from a purely protection standpoint the Performance Mortgage is much stronger then the Memorandum. Some investors have found it difficult to get a seller to agree to sign Performance Mortgage because of the very fact that is does create the lien. I have not had that experience.
If you record the memorandum there is a danger of the title company missing it during the title search. How likely? I would guess unless it was done only a few days prior, they would find it. The one I use seems to do quite well.
At best though the memorandum only puts a cloud on the title and is enough to make people start asking questions. The Memorandum gives you no powers should you be trying to protect your interest. By that I mean your only strategy may be a suit for specific performance.
In addition, the performance mortgage can be used as a sort of asset protection device. Meaning, if the home is highly leveraged from the start (low equity) and you put a second in place that has the value of another $15K or so, this may in fact put the home upside down. The point is, should the seller get a judgement against them for some reason there may be no equity to force sale of the home in order to satisfy the judgement. Not to mention there may not be a lawsuit anyways if the attorney for the other party looks and sees there is nothing to get in the form of equity.
Another point, if the seller does declare bankruptcy, I think it would be quite easy to get a release from the stay imposed by the BK proceedings, barring fraudulent transfer issues. Of course if you buy the home today on a L/O knowing the seller may be decalring BK in a few months you might be in over your head. Then again, you might not.
Also, the other reason many gurus say record the memorandum might be twofold. There might be some sort of tax issue at the county level based on recording the Deed of trust. I actually think the reason they say use it is because they have been advising this for a long time and Bill Bronchick is the one who has taught the method for the last few years and for them to jump on the “Record a Performance Mortgage” bandwagon would admit to a shortfall in their system and there’s too much pride for that. Now, that second reason is purely speculation on my part, but an opinion I hold close.
Ok lets say you negotiate a L/O for a discounted price and then the seller refi’s the house for more than your option price. Is there anyway you can stop this from happening? Any clause you pros use in your contracts?
Thanks,
Nick O
Posted by Tim- chi. on October 01, 2003 at 10:51:42:
Nick,
You should record your option with the recorders office. You have an executory interest in the property that will vest if/when you excercise your option. If the owner/seller attempts to refinance your recorded interest will place a cloud on the title. Also, recording your interest will protect your position should the seller try to sell to a third-party.
if i sold on a lease option, i would specifically put in the contract a clause that would forbid this. if you do go and record (if the seller allows) and he has a mortgage on the property, most lenders have a clause that allows them to call the loan due. as a result of this unfortunate fact, most sellers on a L/O are not going to allow you to record.
Posted by Tim-chi on October 01, 2003 at 15:09:10:
Tom,
I’ve learned that if you need to eat crow it’s a dish best served warm. It appears you are right and I am wrong–an option does violate the due-on-sale clause.
Posted by Tim-chi. on October 01, 2003 at 13:10:42:
Tom,
Are you sure? You say “…if I sold on a lease option”-but this is a misnomer- you’re not selling. There should be two agreements one, a lease giving the lessee a leasehold interest in the property, then a seperate agreement granting the lessee the right to buy the property at a certain price. There is no sale and no transfer of title and therefore the due-on-sale clause is not triggered.
I would not enter a lease w/option to buy if I couldn’t protect my position. What if the owner sells to a third-party who has no knowledge of the option agreement and the option-holder only finds out after the sale?
How would suggest you protect yourself and how would you answer Nick’s initial question.
First, the lanquage of the Garn St Germain Depository Institutions Act states that a lease greater then three years or any lease containing an option is a violation of the due on sale clause.
Some folks say you can skirt around it by having two seperate agreements. It’s likey it will not work because an option in and of itself is a significant transfer of rights and is a violation.
Having said all that, the only thing that remains is if the lender finds out about the option. If you record it there is a chance they might.
The best way to protect your position when you buy using a L/O scenario is to use a “Performance Mortgage (or Deed of Trust)”. This is basically a second, or subseguent lien on the property securing the sellers promise to perform. Should the seller decide they do not wish to play as agreed when the time comes to sell you have the same power as any other secured leinholder, you may foreclose. This is a lot better then sueing for specifc performance.
Additionally, this “Perfromance Mortgage (Deed of Trust)” is on public record and looks like a loan or something to a lending institution, therefore raising no red flags as it is behind them in most positions. Also, should the seller try to refinance the property after they have an agreement with you, there will be a title search done during the course of the refinance and you’ll have some control as to how much (if any) they are able to refinance for.
The “Performance Mortgage (Deed of Trust”) is a powerful document when used properly and to it’s full potential.
I learned about it from Bill Bronchick and when Joe Kaiser made a statement a few years back about it possibly being the best bit of information released in a LONG time, I knew it was something to get a firm understanding of. Once you do understand it, you won’t be sorry you spent the time learning.
So you would advise not to record a noterized memorandom of the option? I agree with the Performance Mortgage but in everything I’ve read, the gurus say to record a memorandom??? Either way you guys have answered my question on the refi. Thanks a lot!
Nick O
this is the correct way to set it up to protect you position from a buyer’s standpoint…still there are significant risks, which involve trust on the buyers part to the sellers actions and intent. not withstanding that, what about if the seller has financial troubles and files bankruptcy? with a lien in place you should come out ok, unless you get into fraudulent transfers…
I personally do not like to buy on L/O. yes the leverage is excellent, and you can on occasion negotiate great payments, but even if you can do the deal no/low money down, significant reserves and the ability to cash out the seller should be in place. many people doing sandwitch L/O do not have such (well at least if you listen to the gurus), and are therefore at high risk. ever look at the quick ratio of a typical L/O buisness?
as to what your lender will allow, why don’t you call them and ask? i have, and so when i have sold on L/O, i have specifically not allowed recording. if you don’t like it, get a loan. what some buyers get poorly informed sellers to agree to downright criminal.
i can agree on this, no one wants a suit for performance.
Posted by Tim- chi. on October 01, 2003 at 14:52:07:
Scott,
Thanks for the post. Perhaps we can agree that it’s best to review this with your attorney before entering a lease w/option to purchase.
One point regarding drafting two separate agreements- my intent was not to “skirt” the due-on-sale as I was working from the belief that the due-on-sale clause was not triggered rather the two agreements are necessary to reflect the two separate interests that are created and therefore they should be separate (in my opinion).