L/O - How do you make money? - Posted by AllanE - NC

Posted by JohnBoy on May 18, 2000 at 24:07:29:

You could always agree to carry back a second mortgage for the difference. Even if the second exceeds the appraisal value, the lender will loan up to their LTV and will allow a second even if it exceeds the property’s value. That’s assuming of course that the buyer qualify’s with enough income to make both payments. But if you had to, you could amortize the second for a longer period of time to keep the payment lower so the buyer can qualify and just add a balloon payment due after x number of years.

But whether the property appreciates enough or not isn’t within my control. The market can go up or down.

What happens if the property appreciated upward to $120k??? Should I be one mad seller because I could have made an extra $10K??

If it appreciates for more then the tenant gets an even better deal. If the property depreciates in value the tenant can just walk away, I’m still stuck with a property that is worth less than what I started with! It works both ways.

What about the homeowner that jumped in and purchased their house while the market was hot and prices kept rising? They sign a 30 year mortgage and within a couple of years the bottom falls out in the market making their home worth tens of thousands less than what their mortgage is? That’s when you see lots of people just walking away from their homes and letting the lenders have them back. These buyers had put down thousands as a down payment, made thousands in mortgage payments and just walked away because their home was worth less than what they owed on it.

The only difference between these homeowners and the tenants leasing with an option is, the tenant can just walk away and loose their option consideration and that’s the end of it. The homeowner that walks away will face foreclosure, bad credit as a result, and face having a judgement against them for the amount the lender lost on the mortgage.

Should I be concerned about which way the market turns in a year from now because I have a tenant expecting it to appreciate? Heck no, that’s completely out of my control. If it were up to me, I would have real estate jumping up where ever I owned property and dropping in value where I can continue to buy low and then make that go up. LOL

L/O - How do you make money? - Posted by AllanE - NC

Posted by AllanE - NC on May 15, 2000 at 15:36:49:

Greetings,

I’m new to REI. I’ve been scaning the message board and reading a lot of messages about L/O.

Basicly, how does one make money with a L/O?

Thank you, in advance.

Re: L/O - How do you make money? - Posted by JohnBoy

Posted by JohnBoy on May 15, 2000 at 19:11:52:

Now that you heard about the way you can make money with a L/O, you’re probably thinking, yeah, but HOW do you go about structuring a deal where you can make money on option consideration, monthly cash flow, and a back end profit, right? Say, why yes brother JohnBoy, that’s exactly what I was thinking. :slight_smile:

Let’s create an example to give you a clearer picture on how this can work. We will use a typical sandwich L/O as an example:

Your the buyer looking to buy a home. I come along and say unto you, yes, I have a home available that I can set you up in with an option to buy. Since you have had some credit problems in the past you can’t qualify to get a mortgage or at least you think you can’t. But I say to you brother Allan, “I can help you become a homeowner and accomplish that American dream of owning a home”! I ask you how much cash you can come up with on this house if I’m willing to help you out and get you into the place? You say, why I can come up with $5k! I say, well, that nots quite what I was looking for, but I think I might be able to work with that. This is where you start to get excited! :slight_smile: Next I tell you that I can give you a one year lease with an option to buy the house at the end of that year for $115k and the rent will be $1,000 a month on this nice little property. Then you say, “Why good God-O-Mighty brother JohnBoy, I’ll take it!”

Now the average house just like this one sells between $90k - $100k in the same neighborhood, but your not concerned about that because you want a house so bad and since you can’t qualify for a loan you don’t mind paying a little more in order to get into one. Besides, you only have an option to buy it later, not an obligation to buy. If market values go up in a year you will be in good or better shape anyway. If not, you can always walk away at the end of your lease. So everything checks out and we do the deal. Your happy, I’m happy, everyone is happy.:slight_smile:

So now your thinking, yeah, that’s all just fine and dandy, but HOW are you making any money on this??? Alright! Your paying attention! That’s good!

Well, let me tell you how:

You see, I found this “motivated” seller that just happened to be the owner of this house. He “NEEDED” to get out from under the mortgage payment he was paying on this house and I just happened to come along and give him a solution to his problem by stopping the bleeding he was going through.

His mortgage payment was $800 a month and his loan balance was $90k. He didn’t have much equity and a realtor would have eaten up any of the equity anyway from their commission to sell the house for him. So yours truely here agrees to L/O the house from him for 5 years and cover his mortgage payment as the rent amount. He’s happy, I’m happy, everyone is happy! :slight_smile:

My rent to the seller is $800, my option price is for $90k locked in for 5 years until I’m ready to exercise my option, which gives me plenty of time to make money on this until I get it sold.

You came in and gave me $5k as “non-refundable option consideration” and will be paying me $1,000 a month in rent for a year. Since all I did was just take over the property by picking up the house payment to bail the seller out of his bind he was in, the $5k you put up goes right in my pocket! Every month when you pay me the $1,000 for rent, I take $800 from that and my rent to the seller (actually I pay it directly to the lender to insure the mortgage payment is getting paid) and the left over $200 goes right in my pocket every month. If you elect to exercise your option at the end of the year then the option consideration of $5k you paid would be deducted from the purchase price your paying. So you would need to come to closing with $110k to buy the house.

How much is my option price with the seller? That’s right, $90k! So that means at closing I would collect another $20k profit after paying off the sellers mortgage.

So how much would I have made in this deal?

$5k up front from the option consideration, plus $200 a month for 12 months from the rent for a total of $2,400 in cash flow, plus $20k at closing when you exercise your option.

$5k + $2,400 + $20k = $27,400 total profit to me!

Now what happens if you don’t exercise your option? No problem! Your lease is up, I still have another 4 years to go! I can offer to extend another year to you, for some additional option consideration and raise the rent up some now that it’s been a year that has passed, or if you decide to walk away, I just start all over again with a new tenant/buyer and get myself another $5k as option consideration and collect another 12 months of cash flow! Bottom line is, I MAKE MORE MONEY!!! :slight_smile:

Say, That’s wild brother JohnBoy! Thank You, Thank You!

Lets, expand the thought process on this just a little more:

Lets say you go out and do just 4 deals like this a year within the same profit margins? That puts you at making almost $110k a year for doing just 4 deals like this example! How many hours would it take to work at the job to earn $110k per year vs. the hours it would take to do 4 of these deals???

Say, Amen brother JohnBoy, for I have now seen the light!

And that’s how you make money with L/O’s. :slight_smile:

As many ways as I can - Posted by Jim IL

Posted by Jim IL on May 15, 2000 at 15:51:22:

Allan,
I am assuming you mean "how do you make money when selling a home using a Lease Option?"
So, with that in mind, I’ll take a stab at your question.
When selling a home using a L/O there are basically three profit centers.

  1. The non-refundable option money from your Tenant Buyer.
  2. Monthly cash flow. (the difference between your payment and the rent you collect.)
  3. Back end Profit. (the difference between what your T/B’er owes you, and what you owe on the underlying loan, contract, or L/O when the T/B’er exercises.)

Some will only do these types of deals when all three of the above are making a profit, and others will only do them for 1 or 2 of the above. To each his own.
The best deal to me, brings in profit from all three.

And, as with any Real Estate Investment, you make your money going in. You want to make sure that your payments are low enough that you can create cash flow.
You also want to make sure your price is low enough to allow you to get a higher price from your tenant buyer (you CAN even pay retail FMV on your L/O and profit in my opinion, since your price to the T/B’er will reflect future value, as well as a premium price for your terms), and this will cover the front end option money as well as the back end profit to you when the T/B’er exercises.
There are also many other ways to create profit in L/O’s, such as assignments, or quick retailing of the home also, but that is best left to another post.

Hope that helps,
Jim IL

Re: L/O - How do you make money? - Posted by Keith Johnson

Posted by Keith Johnson on May 16, 2000 at 16:12:28:

I have a newbie question.

Who covers the other costs such as insurance and property taxes? The original owner or you and how does this impact your numbers?

Re: L/O - How do you make money? - Posted by MStevens

Posted by MStevens on May 15, 2000 at 20:15:52:

Brother Johnboy I have a question. How many people put up 5K then walk after a year? Also how many people with bad credit come to the table with 110K for a house appraised at 100k? How do they get this loan?
Mike

Re: Thank you, for the GREAT response!!! - Posted by AllanE

Posted by AllanE on May 15, 2000 at 18:02:17:

Thank you, for the GREAT response!!!

Re: L/O - How do you make money? - Posted by JohnBoy

Posted by JohnBoy on May 16, 2000 at 23:19:25:

In most cases the seller’s taxes & insurance will be included with the mortgage payments. In some cases the seller may pay their own taxes & insurance. Either way, if there is a mortgage on the property the seller will have to have insurance naming the lender as a loss payee to cover the lenders interest on the mortgage. You would have the seller name you as an additional insured on the policy and he will need to have the homeowners policy converted to a hazard policy since he won’t be occupying it any longer.

If the taxes & insurance are included in the mortgage payment then that cost is covered if you’re taking over the payment amount. If it’s not included and the mortgage payment only covers principle & interest then you would need to figure in the cost of taxes & insurance and add that amount to your monthly payment to the seller. You should always have an escrow account set up by a 3rd party like a title company, bank or attorney to send these payments to every month to guarantee the money will be there to pay the taxes & insurance when they come due. Never pay the seller directly or you take the risk of him/her using that money for their own personal use and before you know it, you’re having problems with the lender for non-payment on the mortgage and/or taxes & insurance. Once the seller walks away letting you just take over their property they may not care about making that payment and using that money for other things. Protect yourself!

If the payment to the seller is more than his/her mortgage, taxes, and insurance payment, then you can set it up to where the mortgage, taxes, and insurance get paid first, then anything remaining gets sent to the seller. You would do this the same way with your tenant/buyer.

Have the rent payment from your tenant/buyer sent to the escrow account. The escrow account then pays the lender, taxes, insurance, and the seller if they have anything left coming to them, and then the rest is sent to you.

The tenant would have to get their own insurance called a renters policy to cover their own personal contents in the property.

Re: L/O - How do you make money? - Posted by JohnBoy

Posted by JohnBoy on May 15, 2000 at 20:54:32:

A lot!

I didn’t say BAD credit, I said “some credit problems in the past”. Some credit problems doesn’t mean Bad Credit! A lot of people just “THINK” they can’t get a loan because of past credit problems.

If a house is worth $100k today, would it be unreasonable to estimate that property may be worth $110k a year from now? I don’t see it as being unreasonable and no one can predict what will happen a year from now. The value can increase or decline, no one can guarantee what it will do. Can you?

During the period of that year the tenant is leasing they should be working on re-establishing their credit if it isn’t good enough to get a loan today. If they could get a loan then they certainly wouldn’t have any use for my services. If the tenant does all the things they’re suppose to do during that year and establish a payment history of making their payments on time, they can get a loan. Some lenders will even treat a L/O the same as a refi just like a contract for deed. A refi would allow them to qualify for a much higher LTV vs. a purchase. If they can’t qualify for a new first they may qualify for a CLTV by getting a smaller first and a second. If that doesn’t work, the seller (me) can carry back a small second to help them qualify. That’s of course they’ve done all the things they were required to do over the course of the year as in, making the payments on time, cleaning up any credit blemishes they may have, establishing credit if needed, etc. That’s where working with a good mortgage broker comes in. A good mortgage broker can help you with getting the tenant financed in a year by outlining a plan that the tenant will need to stick to and perform on. If they don’t perform on their end then there’s not much I can do for them after that.

Bottom line is, pre-qualify your tenant/buyer before putting them into the property.

You can lead a horse to water, but you can’t make him drink it!

If the tenant performs and does everything they were supposed to do, and they still can’t qualify for a new loan, then just re-new the contract for another year to extend them more time. If they don’t perform on their part, then that’s their problem.

And that brother Mike, is how to do it.

Re: L/O - How do you make money? - Posted by Dew

Posted by Dew on May 17, 2000 at 20:47:13:

Great info. John Boy, but how do I know the seller added me as an additional insured, do I get written confirmation automatically for insurance co.? And, doesn’t the seller’s lender invoke the due on sale clause when the seller changes the insurance policy to hazard and names you(me)as an additional insured?

Thanks much, appreciate your time and info.

Re: L/O - How do you make money? - Posted by Keith Johnson

Posted by Keith Johnson on May 17, 2000 at 11:49:58:

I appreciate the detailed info JohnBoy. Thanks.

Re: L/O - How do you make money? - Posted by Ed Reilly

Posted by Ed Reilly on May 16, 2000 at 10:40:39:

Seems like it would be a good idea if you could hand them a pamphlet that would give ways to improve their credit over the year, getting them thinking that it really is possible to buy this house. Anybody do this or know where one might get one?

Thanks,
Ed/Montco.PA

Re: L/O - How do you make money? - Posted by JohnBoy

Posted by JohnBoy on May 18, 2000 at 24:14:40:

Usually the lender never notices because insurance is processed elsewhere within the banking system. The person processing the paper work usually never pays attention to things like this. I’ve changed policies over to hazard policies and never heard a word about it from the lender. In fact, if the lender finds out your renting the property they will usually tell you to change to a hazard policy. I’ve had this happen with a seller I was lease optioning from. No big deal.

The sellers insurance company or broker will send you a binder naming you as additional insured. It doesn’t change the policy with the bank. It only adds you as an additional insured.

Re: L/O - How do you make money? - Posted by Ed Reilly

Posted by Ed Reilly on May 17, 2000 at 07:12:39:

My question was somewhat in response to MStevens’ concern about somebody who does not believe that they can buy a home because of their credit, then putting up 5k for the right to do so in a year. Giving them pointers on how to improve their credit may help them to believe that it is worthwhile. Also, your assumption is that making profit is the only motive here. That is not necessarily true, some people do enjoy the feeling of helping others. Just my opinion. Happy investing.

Ed.

Re: L/O - How do you make money? - Posted by JohnBoy

Posted by JohnBoy on May 16, 2000 at 23:31:20:

My feeling is that I’m dealing with adults, not children. I’m not going to hold their hand every step of the way hoping they will perform. Each person will have different issues pertaining to what they may need to do for their own personal circumstances. I don’t a generalized pamplet will address everyones own unique situation. I would evaluate their credit along with a good mortgage broker and determine a good plan for them to follow if they’re ever going to have any hopes of buying the property. Once I’ve done that then they’re on their own and it’s up to them to hold their own hand and perform. The bottom line is simple, if you want to be able to buy the house, then perform on what was outlined and stick to it! Period!

If they’ve done all the things required by them and they still had a problem getting financed then I would extend them another year if needed. It may require them to pay a higher rent that extra year and/or some more option consideration to extend the option. It may also include raising the option price since it will be another year before they can buy. I may have a soft heart (so I’m told by my attorney LOL) but Santa Claus I’m not! :slight_smile:

Re: L/O - How do you make money? - Posted by Rocker Fella

Posted by Rocker Fella on May 16, 2000 at 19:33:41:

Hi…mind if I butt in here, uhh well…I dont claim to know anything, I am just an amature waiting to jump in on some of this RE action, butin answer to your question, …even if the young man cant afford or qualify to actually purchase that house after a years time of leasing, it still wont hurt the person doing the leasing. He got his $5k up front plus his $1000 per month. So after the first year if the leasor cant buy the house he just gets kicked out and the leasor can find another person to lease option to with the same exact deal. Seems like a good deal unless I am missing something…am I?

Re: L/O - How do you make money? - Posted by JohnBoy

Posted by JohnBoy on May 16, 2000 at 23:38:42:

You’re right, I would have made my money and if they screw up, then they will make me more money because I get to do it all over again on the same property.

However, if they have performed by doing all the things they were suppose to do, I wouldn’t just kick them out in a year just because I can do it all over again. IF they performed and still had a problem getting a loan, then I wouldn’t have any problem in working with them to extend them another year.

Hmmmm??? Maybe I am Santa Claus?? LOL

Re: L/O - How do you make money? - Posted by dew

Posted by dew on May 17, 2000 at 20:55:07:

So the T/B gets their credit in order at the end ofa the year. But the property, oops, doesn’t appreciate to $110,000. What happens now, you have one mad T/B and then . . . .
Thanks again for the assist.