Lease/Option and Due on Sale clause... - Posted by Marc

Posted by Lisa Jones on December 10, 1999 at 20:47:57:

Thanks for such a detailed answer.

Lease/Option and Due on Sale clause… - Posted by Marc

Posted by Marc on December 07, 1999 at 22:51:08:

I have recently found a seller willing to let me lease/option his house. I want to present him with a combined lease/option contract, but I’m weary of the due on sale clause.

The seller is buying a new home and needs to qualify for the mortgage. He’ll need to present the contract to the broker in order to qualify. How can I combine the lease and the option without triggering the Due on Sale clause?

Is it necessary to separate the lease and the option in this situation?

Re: Lease/Option and Due on Sale clause… - Posted by Bud Branstetter

Posted by Bud Branstetter on December 08, 1999 at 10:05:12:

I’m weary of all the talk about the due on sale clause. Why would a lease violate the DOS clause. Does the note prohibit renting the place out. Read it to be sure.

The problem with a lease on the property is that the lender only gives 75% credit for income but 100% of the mortgage is used as a debt. When they need a 38% back end ratio to qualify it does effect in a negative manner. However, if you create a contract for deed instead the lender will likely count it as a sale and have no effect on their ratios.

Re: Lease/Option and Due on Sale clause… - Posted by Judy

Posted by Judy on December 08, 1999 at 08:44:17:

A few years ago I had a house that we had under a lease with option combined contract. During this time we refinanced the house and showed the lender the agreement because we needed the income on it to qualify. We got the loan and they never said anything about it violating the due on sale or any problem. I quess it must depend on lender. The new refi was with the same lender as original loan. Maybe we got lucky on this and it was somehow missed. I dont think I would try it again after reading all the posts about the due on sale problem.
Judy

Re: Lease/Option and Due on Sale clause… - Posted by Jim IL

Posted by Jim IL on December 08, 1999 at 02:18:02:

Marc,
Is the mortgage company the same one?
Frankly, I would not worry about it.
If the seller can qualify for the new loan, then the broker will make sure everything is alright.
A broker only gets paid if the deal gets funded, so you can bet, if the broker is worth his salt, he will take care of whatever arrises.

A L/O will violate the Due on Sale, but remember, most DOS clauses state that the lender can call the loan, at there "option."
Does that mean it will not happen?
Maybe, maybe not.
Never know til you try.

Besides, the only one who stands to lose is the seller, not you.

Good luck,
Jim IL

P.S. I would still go ahead and use a combined L/O contract, and not a seperate Lease and Option. This protects you.

Re: Lease/Option and Due on Sale clause… - Posted by Bill Gatten

Posted by Bill Gatten on December 08, 1999 at 12:40:56:

I don’t want to start another DOS brooha(sp…I know, Jim: bruha?) here, but the irrefutable facts are:

Technically (note the term “technically”) any option to purchase does indeed violate the provisions of the Garn St. Germain Act concerning the DOS Clause ("any lease for more than 3 years, or containing an option to purchase… HOWEVER (screaming here) “HOWEVER,” with residential property financed by a conforming or non-confirming non-private lender, the chance of the note’s being called for that reason alone is nil (unless, as Ray Alcorn said on the Andy Griffith show below) someone out there is just looking a reason to screw someone.

On the subject of the “Debt to Rental Income” Ratio, Bud B. is right: you could create a Contract for Deed and avoid the problem (probably); however…in doing so, you come even closer to the original DOS issue than you would have been with a simple Option (a Contract for Deed or Sale" is definately a DOS violation).

In transactions where a new loan is needed by the seller, I solve the problem with a PACTrust(duh…suprise!)…I have a standard form letter that goes out to the seller’s (optionor’s) new lender, explaining that the property is being held in a PACTrust, and that the triple net lease tenant is a beneficiary of the trust, with a long term lease on the property… with a full contractual obligation to cover 100% of all payments, repairs, upkeep, property tax and insurance; and with an obligation to either sell or refi at termination. This shows the bank there is no negative CF, no maintenace or management expense, and gives them(the new lender) the justification they need to underwrite the loan as if the property had indeed been sold on a Contract or a wrap, without actually having to do it that way. They’ll generally want to have a copy of the trust, the assignment and the occupancy agreement for their files (not one has ever ask for, or bothered to check, the credit of the co-beneficiary). And…the PACTrust can be structured with exactly the same objectives and intent of a Lease Option should you choose to retain that objective.

Over the years, I’ve sent out–easily–50 of those letters, and to my knowledge, there has been only one lender who balked at making the loan (a small bank in Boulder, Colorado); whereupon, the client merely went elsewhere for his loan.

Note that with the PACTrust there is no need of protecting the conveyance with any form of public notice (notification, memorandum, etc.): its wholly private, secret, anonymous and silent. Irrespective of whether or not the PACTrust could be seen to violate the DOS or not, all the lender ever sees is that the property has been placed into a living trust in full conformity with their own regulations and with those of the Garn St. Germain legislation.

Bill

Re: Lease/Option and Due on Sale clause… - Posted by Marc

Posted by Marc on December 09, 1999 at 01:29:35:

I’ve already presented the seller with a separate lease and option. (I don’t think it would have been a problem combining them, viewing it now.) I think this deal has a low risk of creating issues with the seller, though.

For future reference, what are the benefits of combining them, other than the foreclosure vs. the eviction? In preparing the documents, it seemed as though there were some advantages to separating them. If the lease is ended prematurely, the option remains valid (as it was written for the full term +extensions).

Also, with the Mortgage and the Memo of Option, it doesn’t seem as if the seller could do much after evicting. It shouldn’t be in his best interest.

Marc

Re: Lease/Option and Due on Sale clause… - Posted by Erskine

Posted by Erskine on December 08, 1999 at 06:45:03:

When dealing with the DOS clause how does one deal with issues such as contacting the insurance company to be named as an additional issured without causing problems? Maybe they would want to know who this person is and why he wants to be added now that I, for example, is the buyer under a L/O contract. The seller in these situation should not contact their lender at all, right? The same of course holds true for the T/B without question…

What occurs if after being in the property for a few months the lender finds out that a T/B is in the home and calls the loan due. As the seller under a lease option arrangment what position does that places me in at the point in terms of legal liability?

The strong discussion going on regarding this matter on this board left me compeletly confused regarding whether to worry about this issue, get a PactTrust, land trust, or move on without worry. As a newcomer, simply want to avoid trouble.

Re: Lease/Option and Due on Sale clause… - Posted by Brad Crouch

Posted by Brad Crouch on December 09, 1999 at 03:22:48:

Marc,

It’s a matter of “equitable interest”. When you are the master lease holder, having “equitable interest” in the property is a GOOD thing . . . for you. Using one document with the lease and the option combined, strengthens your position. You have a better chance of getting an eviction case delayed and increase costs for the seller by “delaying” and getting the case moved to a different court which is geared for foreclosures rather than evictions.

But you want the tenant buyer to have as little strength as possible when “fighting” with you. So you use two separate documents with him. One is simply a lease which makes no referance to the existance of an option to purchase. The other document is an option to purchase.

If the tenant CAN actually afford an attorney (defaulting on the monthly is not a good sign that he can afford legal fees) and shows up in court, there is a chance that by then he will have misplaced the document(s), and not have his copy of the option.

It would be better for you if the above senario actually occurred. But if/when the subject of an option to purchase arises, the argument that the buyer can keep the option, you just want him out based on the default of the lease. This MAY keep the case from getting to the foreclosure court, saving you months of lost income and payments to the seller.

Of course if the option remains in force for the errant tenant buyer, you won’t be able to offer an “option to purchase” to any subsequent occupants until the option still in force, has expired.

A tenant buyer may “desire” to have extensions, but unless it specifically says in the agreement that the option will be extended, it is still your choice whether to extend or not. You don’t have to, under those circumstances.

After evicting a defaulting tenant who still has an option, you can just lease the property without giving a written option.

I’m not a lawyer.

Brad

Steps to take - Posted by Brad Crouch

Posted by Brad Crouch on December 08, 1999 at 15:44:23:

Erskine,

Step 1: Have the seller put the property into a land trust using a trustee of YOUR choice.

Step 2: Record the deed in the name of the trust/trustee.

Step 3: Seller contacts lender to report that the property is now in an “inter vivos” trust and that any notices in the future are to be sent to the trustee (and give the trustee address). This is quite legal and permitted under the Garn St Germain Act, and does not trigger the “due on sale”, as long as title does not change into a corporate (or other business entity name), and as long as the seller retains “some” beneficial interest in the trust. Since at this point the title is still in the name of a trust, with the “borrower” holding the “beneficial interest” in the trust, no problem.

Step 4: Seller contacts insurance company and says the same thing that was told to the lender, and further arranges to have trustee named as “additional insured”. The insurance company sends notice to the lender (as a matter of policy), stating that “changes” have been made to the policy. This is old news to the lender as they have already been notified. Lenders view this as an “estate planning” move, and are not concerned.

Step 5: Seller assigns beneficial interest to you (either all or part, depending on how “safe” you want to feel), as per negotiated agreement. The “due on sale” clause COULD be triggered if the seller totally divests himself of ALL beneficial interest, if the lender found out this had happened. Since the assignment of beneficial interest to you is NOT recorded, the chances of the lender finding out about the transaction, are slim. The trust agreement and subsequent assignment documents are NOT recorded, and remain in YOUR filing cabinet.

Step 6: Use any method you want for “disposing” or “using” the property for a profit. Just make sure the payments to the lender are never late.

So how would the lender find out anything? Unless you or the tenant buyer say something . . . NOBODY ELSE KNOWS! (As long as the loan is kept current). But yes, the loan COULD end up being called “due”. You should have a plan for that contingency. Either pay it off (assuming you have been in RE investing long enough to have amassed that much money), or refinance, or use a hard money lender, get a new traditional loan (if you have the credit), or sell the place, or assign your agreements to someone else who has the means to handle this situation. There ARE some risks involved in this business. You need to be willing to take them. You can make additional money by assuming the risks that nobody else will assume. It depends on how “comfortable” you want to be.

Folks are talking all the time on this board about “violating” the DOS. Really, there is nothing to “violate”. There is no clause that says the borrower is “forbidden” to transfer his interests. That would be against the law! Those clauses only say that if a borrower “should” transfer his interests, the lender has the “option” to call the loan due. So there is no “violation” here. What there is is a “triggering mechanism”.

A PACTrust is simply a land trust with a little more documentation and legal protection for all parties involved (protection from each other AND any judgement creditors who might like to get their hands on the properties, inculding the IRS). It also clarifies the “duties” of everyone involved, and creates a good senario, profit wise, for all parties. It’s the best method that I’ve ever seen for owner finance deals, relative to structure and legal protection.

Complicated in spots, but the PACTrust itself is not “sold”. It’s simply the “tool that you use” to structure a deal that gives the sellers what they want, while allowing you to profit, too. And there are benefits to the person occupying the property that are previously unheard of.

I suggest that you start at the beginning with a good knowledge of trusts. Bill Bronchick has a course (available on this site - catalog section) that is absolutely great. You need to crawl before you can walk, and this is an excellent place to start.

When you learn what a trust is and how they work, you can “graduate” to more sophisticated techniques.

Hope this helps,

Brad