Many of today’s borrowers, even those anticipating a smooth refinance, are having difficulty qualifying for a loan on their principal residence. Homeowners became so used to the quick turnarounds during the easy-money days that they are startled, and often upset, when they can’t receive the exact loan they want.
Second-home buyers also are being scrutinized because their income may have to cover two mortgages. Lenders simply are being more selective. With property values in some regions remaining flat, more emphasis is being put on a borrower’s income and assets. The lender has to make certain that the borrower has the means to repay the debt.
Recently, a couple made an offer on a lakeside home, mainly because the owners advertised that they were "willing to carry the paper." The buyers preferred another home in the area, but did not meet the bank’s qualifications for a loan. They did, however, pass the sellers’ test and the deal worked out for both parties. The sellers were also correct in assuming their offer to provider seller financing would attract a larger pool of buyers, enabling them to fulfill their goal of selling the home by a specific date.
Seller financing, where the seller accepts a downpayment and then monthly payments, can make sense. Most of the time, seller financing works well for both sides, but both sides — especially the seller — should be prepared to handle the deal much like a small business. While the buyer can simply mail you a check every month, it’s up to you to craft the ground rules.
In many states, most transactions are now closed via a note and deed of trust; other states use real estate contracts. Few sellers, and even some agents, truly understand the difference between a real estate contract and the note and deed of trust. But the distinctions are important, and knowing the differences up front could save money and worry later.
Both a real estate contract and a promissory note secured by a deed of trust recorded against the title to the property permit the seller to loan money to the buyer. The main difference between a real estate contract and a note and deed of trust in most states is the time it takes to remove the borrower/buyer’s interest in the property if the borrower defaults.
The real estate contract, like any other contract, is subject to different interpretations, and runs a greater risk of disputes and litigation. The process of clearing the title can be time consuming and costly, especially if either party challenges the forfeiture. In order to avoid an even more complex procedure, the buyer usually has to be located.
The deed of trust foreclosure takes about 150-180 days, culminating with a trustee’s sale. The borrower/buyer may settle the debt up until 11 days before the sale.
Under a real estate contract, the seller continues to hold legal title to the property until the buyer completes his obligations (finishes making his payments). In the interim, the buyer gets possession of the property and is said to have "equitable title" to the property. Even though in most cases the seller delivers to escrow a fully executed statutory warranty deed, the deed is not recorded by the escrow until the debt is paid in full.
During the entire term of the contract, the seller is referred to as the contract "vendor" subject to the rights of the buyer to complete payment under the contract and to receive the warranty deed. The buyer is referred to as the contract "vendee."
With a note and deed of trust, the seller delivers a statutory warranty deed to the buyer at closing. The buyer then owns the property, subject to the seller’s security interest (the amount of money still owed to the seller).
In addition to an easier foreclosure process, another advantage is that there is a greater market for the sale of the investment interest secured by the note and deed of trust. There are several national buyers for notes. (If you are holding a note, you probably have received offers to purchase the note from mass marketers.)
While it may usually take longer to obtain clear title under a note and deed of trust, the real estate contract can be more cumbersome. The seller also can incur the cost and delay of the court proceedings when using a real estate contract.
If you are participating in seller financing, make sure both sides understand what type of "paper" is going to be carried.
Tom Kelly’s book "Cashing In on a Second Home in Mexico: How to Buy, Rent and Profit from Property South of the Border" was written with Mitch Creekmore, senior vice president of Houston-based Stewart International. The book is available in retail stores, on Amazon.com and on tomkelly.com.
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