Posted by Michael Murray on April 04, 1999 at 22:09:55:
JohnBoy,
Thanks to you and BankRobber, I see now where I need to adjust the deal.
Michael Murray
This seems too easy, what am I missing? - Posted by Michael Murray
Posted by Michael Murray on April 01, 1999 at 11:21:26:
I posted this question on the Cash Flow forum yesterday and thought I would also like to run it past all of you great folks on this board too. It has to do with using notes and RE together. The basic idea came from Alex Gurevich’s article under Money Ideas entitled “Cash In Your Pocket Plus Cash Flow”
I have been intrigued by the idea of creating a mortgage on a property not yet owned, to
fund the purchase of that property. I think I have a pretty good grip on how that can work
and am thinking through the process before trying it on a piece of property my wife and I
want to buy for our future residence. Before I blunder into some catastrophe because I
missed something important, will you kindly review how I plan to structure the deal and
give a quick critique?
Listed price $495,000 On market 8 months, with Realtor
Owned free and clear, no liens, 3,500 sf house, 41 acres
Several low-ball offers by others rejected
Seller wants full price which was established by Realtor
Seller unmotivated, in no hurry to sell
No appraisal has been done
The Deal: Offer slightly more than listed price - $500,000
-Ask seller to take back 2nd for $250,000 at zero interest and 5 yr. balloon for $250,000
-Create 1st mortgage for $375,000 - 75% LTV
at 12% 30 yrs
-Sell note to buyer for $375,000
-Pay $250,000 to seller at closing
-Cash to me $125,000 less closing costs
-Pay one year in advance from proceeds to note
buyer ($46,288) to self-season note and increase buyer confidence
-Begin depositing $4,167 per mo. into an escrow for retirement of balloon in 5 yrs.
Questions: Will a note buyer be interested at 75% LTV? and 12% interest?
How much discount should I ask for to prepay the first year in advance?
Assuming I can handle the payments, this seems too easy. Where am I messing up?
Thanks,
Michael Murray
exercise in futility - Posted by BankRobber
Posted by BankRobber on April 01, 1999 at 23:20:44:
this type of scam may work on motivated owners of 100k properties, but there is very very little chance this Seller will seriously consider your offer. He/she might even counter you as a joke.
Re: This seems too easy, what am I missing? - Posted by JohnBoy
Posted by JohnBoy on April 01, 1999 at 21:13:53:
Ok, let me see if I got this right? Your going to offer $500k as the purchase price. Then your going to create a new first for $375k and a second for $250k. Now your up to a total of $625k for the property.
You want to sell the note to a note buyer at closing. Let’s assume your able to get 95% on the note. That’s $356,250 in cash at closing. You give the seller $250k. Now your down to $106,250 which you will give another $46,288 to the note buyer to pre-pay the first years mortgage payments. That leaves you with $59,962 minus all your closing costs where you might end up walking with $50k at closing.
Your payments on the $375k will be $3,857 which you already paid for the first 12 months. During the first year your only payment will be the $4,167 your putting into escrow towards paying off the $250k balloon in 5 years.
Starting the second year your monthly payments on the $375k note will start again at $3,857 plus the $4,167 towards the escrow account. So years 2 - 5 your total monthly payments will be up to $8,024. (Is this affordable for you?)
So if I’m getting this right, your actually paying $575k after deducting the $50k you walk away with from closing, for a property that is listed at $495k.
What about offering the seller his asking price if he’ll pay all closing costs and carry a 30% second at 0 interest, 0 payments with a 5 year balloon? If your credit is good you can get a 100% financing with a seller carry back.
A new 70% first at 8.5% for 30 years would be $346,500 with a monthly payment of $2,664. If you do the escrow thing for the second you would need $2,475 a month to cover the balloon in 5 years. Your total monthly payment would be $5,139 instead of $8,024 and your actually paying $495k instead of $575k after deducting the $50k you would have walked away with at closing. That saves you $2,885 a month in payments and $75k on the inflated purchase price.
With your proposal you would pay $3,857 x 60 = $231,420 in the first 5 years on the $375k first. Another $4,167 x 60 = $250k on the balloon, with a balance owed on the principle of $366,237 after the first 5 years.
With the example I just gave you would pay $2,664 x 60 = $159,840 in the first 5 years on the $346,500 first. Another $2,475 x 60 = $148,500 on the balloon, with a balanced owed on the principle of $330,873 after the first 5 years.
Your plans total cost: $231,420 + $250k + $366,237 = $847,657 over 5 years.
Example plans total cost: $159,840 + $148,500 + $330,873 = $639,213 over 5 years.
$847,657 - $639,213 = $208,444 total savings. (Is $208,444 worth paying over 5 years to put $50k in your pocket at closing?) That averages out to be $3,474 a month for 5 years to make up for the $50k cash at closing. That’s like paying 81 3/4% interest over 5 years on that $50k!
Unless I missed something myself, where’s the deal?
Re: This seems too easy, what am I missing? - Posted by Charles - DFW
Posted by Charles - DFW on April 01, 1999 at 19:03:05:
First thing I recommend you do is talk to a mortgage broker about different types of financing available.
A 75% LTV first loan should be about 10%. The advantage in using the create your own loan, is when you need to close a deal fast, 10days or so. The other advantage is taking money out of the deal. Thats why you pay about 18% (yield to investor).
The biggest problem I see with your deal, is the seller is not likely to agree. You want them to agree to a 50% second, subordinated (redundant) to a 75% first.
Charles
Re: This seems too easy, what am I missing? - Posted by DanM(OR)
Posted by DanM(OR) on April 01, 1999 at 17:38:33:
Michael,
I am almost sure you have already, so forgive me if you have. However, I think you should run this through the Lease/Purchase scenario. It may be an ideal situation. With large rent credits your principal buy-down would be substantial. It may also help the seller with their cap gains problem.
Best of luck on this deal.
Your friend in RE,
Dan Matejsek
Re: This seems too easy, what am I missing? - Posted by David Alexander
Posted by David Alexander on April 01, 1999 at 15:52:25:
You’ve got the basis right, as far as discount that would depend on who your selling to, a broker, an Institution, a principal buyer. What sandy was talking about below is when dealing with a broker to Institutions. The biggest hang up I can see is finding a principal buyer for the mortgage, others may not think this is so and getting the seller to go that long without money, then again, it sure don’t hurt to ask.
Are you sure you can make a 48% return a year on the 100k. If you need some help, Holler. LOL.
Do you really want a 500k house for two people. Sounds like you could get lost.
David Alexander
Re: This seems too easy, what am I missing? - Posted by David Alexander
Posted by David Alexander on April 01, 1999 at 15:52:25:
You’ve got the basis right, as far as discount that would depend on who your selling to, a broker, an Institution, a principal buyer. What sandy was talking about below is when dealing with a broker to Institutions. The biggest hang up I can see is finding a principal buyer for the mortgage, others may not think this is so and getting the seller to go that long without money, then again, it sure don’t hurt to ask.
Are you sure you can make a 48% return a year on the 100k. If you need some help, Holler. LOL.
Do you really want a 500k house for two people. Sounds like you could get lost.
David Alexander
Re: This seems too easy, what am I missing? - Posted by Sandy FL
Posted by Sandy FL on April 01, 1999 at 15:08:16:
I see… you offer him his price, and get him to agree
to your terms (half now and half later). So the hard part
would be selling this scenario to the seller.
As far as the note stuff, I will defer to Bud and Behle…
but this is what I ‘think’ goes on…
If you sell a new first mortgage to a note buyer, I
think you will generally net 90-93% of the face amount.
That would be 337k - 348k. That leaves 87k - 98k to
play for closing costs and go in your pocket.
Depending upon your FICO score, a 12% interest rate may
not be necessary… but as far as the prepayments and
using this to reduce the discount, do they do that?
Ya lost me there.
I gotta visit that cash flow column more often…
Sandy
Re: This seems too easy, what am I missing? - Posted by Sandy FL
Posted by Sandy FL on April 01, 1999 at 15:08:16:
I see… you offer him his price, and get him to agree
to your terms (half now and half later). So the hard part
would be selling this scenario to the seller.
As far as the note stuff, I will defer to Bud and Behle…
but this is what I ‘think’ goes on…
If you sell a new first mortgage to a note buyer, I
think you will generally net 90-93% of the face amount.
That would be 337k - 348k. That leaves 87k - 98k to
play for closing costs and go in your pocket.
Depending upon your FICO score, a 12% interest rate may
not be necessary… but as far as the prepayments and
using this to reduce the discount, do they do that?
Ya lost me there.
I gotta visit that cash flow column more often…
Sandy
Re: exercise in futility - Posted by David Alexander
Posted by David Alexander on April 02, 1999 at 10:34:37:
Not True, you don’t know what you can get till you ask. Did your read the part that they don’t want all cash for tax reasons. At the very least it will open negotiations. Sounds to me you would kill a deal because you don’t believe you could sell it before you even start. Like I said “You don’t know till you ask”
but, part of it is you have to believe with conviction that it is doable, otherwise the seller will sense it and balk.
David Alexander
Scam? Wh…I…What? SCAM??? Excuse me? - Posted by Michael Murray
Posted by Michael Murray on April 02, 1999 at 09:41:36:
Boy, you got me there! How did you come up with that? If you can show me anything in that proposal that even hints of a scam, I would like to hear your explanation. Perhaps someone named BankRobber has some “inside” information?
Thanks, (you’re joking, right?)
Michael Murray
sounds like a Realtor talking - Posted by P.V.
Posted by P.V. on April 02, 1999 at 09:23:51:
What exactly did you object to… the fact that the
seller was getting his price (and then some)?
The fact that the Realtor is getting his commission?
The fact that Michael is trying to figure out what the
seller wants? The fact that Michael could put money in
his pocket at closing? (Get the handcuffs! Its a scam!)
Thanks, JohnBoy and all who helped. - Posted by Michael Murray
Posted by Michael Murray on April 01, 1999 at 22:37:09:
Hi JohnBoy,
Thanks for doing all of that work and for the suggestions, very helpful. You are right that the purchase price would be higher than the asking price. I was figuring I could get 100% on a new 75% LTV note at 12% interest. Apparently that is unrealistic? That would let me walk away from closing after pre-paying the first year with something around $75k which I was planning to invest into the property for improvements. I would end up having paid about $550k for a property worth around $650k after improvements. Charles, in the post below, thinks I should be able to get the first loan for 10%, which would make the deal better.
However, I like your idea about going for a conventional 70% - 75% loan at 8.5% with an owner carry back for the difference. Thanks for fleshing the numbers out, those payments were looking pretty scary. Thanks to everyone who offered their help and opinions, that’s what makes this site really great!
Michael Murray
Good thought, but… - Posted by Michael Murray
Posted by Michael Murray on April 01, 1999 at 17:46:35:
Thanks Dan,
I did think of that, but I found out that two previous offers in the L/O mode were rejected. So that is why I thought this idea might be the ticket.
Michael Murray
Point of negotiation - Posted by Michael Murray
Posted by Michael Murray on April 01, 1999 at 17:13:03:
Hi David,
I appreciate the thoughts. I have a little inside information from the Realtor. The seller is in a tax position where he does not want to take the entire sale at once. I don’t know if he will go for so long without interest or payments on the balloon, but, if not, that will be another point of negotiation if the deal needs additional sweetening. As for getting lost in the house, we also have a gang of horses, dogs, and other critters, not all of which will live in the house, of course, but we like lots of elbow room.
Thanks,
Michael Murray
Incentive - Posted by Michael Murray
Posted by Michael Murray on April 01, 1999 at 16:59:32:
Hi Sandy,
Thanks for the input. The 12 month’s pre-payment on the 1st is for three reasons:
- To self-season the note to make it easier to refi.
- To increase confidence in the mind of the note buyer. He doesn’t
have to worry about delinquency for a year. - In keeping with the spirit of discounting notes for quicker payment, there should be a discount negotiable from the buyer of the 1st for a lump-sum payment of an entire year up front. This could amount to several thousand dollars off.
This may seem like the note buyer is paying himself since I am paying him out of the proceeds of the note. But it is not all smoke and mirrors, it is just that everything happens at once at closing. Since the entire deal is secured by the property which I ultimately have to pay for, everyone should be happy.
Clear as mud?
Michael Murray
Re: Scam? Wh…I…What? SCAM??? Excuse me? - Posted by BankRobber
Posted by BankRobber on April 02, 1999 at 19:09:58:
Even if you did not conspire with the lender and you were foreclosed on the 1st day after your prepaid interest payments expired the Seller would be out more than $140K. Only an idiot Seller would agree to a carry back with those terms. But, what the Millionaire Seller knows and you do not is that you could conspire with the Hard money lender so that after the 1st year of prepaid loan payments ends, you will stop making payments on the $375,000 1st Deed of Trust, interest will accrue on the 1st DOT at the 20+% Default rate, then the 1st DOT will foreclose off the 2nd (now worthless) DOT after about 14 months of nonpayment on the 1st (balance of approx. $470,000 now on the 1st DOT). You (and possibly the hard money lender) will have effectively picked up a $495,000 property for the initial cash to Seller ($250,000) plus 2.5 years of hard money interest costs on $375,000 (approx. $150,000), plus 2.5 years of tax and insurance costs (approx. $15,000), less initial cash to you ($125,000) less 2.5 years of rental income (approx. $75,000), a total of only $215,000!. Pretty good scam!
Re: Point of negotiation - Posted by Bud Branstetter
Posted by Bud Branstetter on April 01, 1999 at 17:26:48:
Michael,
Something doesn’t fit. Is this not their principle residence? You are aware that if they sell their residence and have owned for 5 years and lived there 2 of the 5 that 500K of the gain is tax free. If you can help them solve their problem this way you should be able to deal. L/O so they own for 5 years. Keep the utilities in their name etc to make 2 years. The minute you tell them the how you may blow the deal. Make sure you have concurrance on the deal before you tell them how.
On selling the note scenario-the house will have to appraise and you will have to have the income.
Re: Incentive - Posted by Sandy FL
Posted by Sandy FL on April 01, 1999 at 17:06:00:
Thanks Michael… that does help explain it. And it does sure make sense. Does the pre-seasoning money stay in escrow and get paid out monthly, or does the lump sum change hands simultaneously with everything else? (I hope that is not a stupid question)
The lights have just come ‘on’ for me recently with this note stuff. I am glad you started this thread.
Sandy