Jan 27 2008
Sell your home and stay put.
I had an interesting conversation today with a friend of mine we’ll call Ed. His family is in the same situation of a lot of other people: his ARM interest rate has reset to over 10%, making it difficult to make mortgage payments on time or at all. He had been more than 30 days late on a mortgage payment 6 months ago, but he has been trying to improve his credit rating to refinance and get out of the mess he is in.
Lenders are rarely willing to take a chance in a market like this. Within a few months, Ed would have lost his home. I envisioned his situation as if he were in a movie, hanging onto a small plant just off the edge of the cliff hoping somehow he could keep his home. Luckily, someone reached out their hand.
The Angel’s Hand
About a week ago Ed sat down at his kitchen table with two close friends to listen to a provocative proposition. His friend offered to buy his home. Interest rates on new loans are low and people with good credit can get great rates. The catch is, Ed’s friend wants Ed to “rent” the house from them.
Ed’s payments per month are decreased by over $1000, allowing Ed to keep his head above water and even save a little and work on his credit rating. I was unable to get the rest of the details, but this really got my mind thinking about the sub prime crisis.
Modified Lease Option
A lease option allows the buyer to lease a house with the option to buy in the future. This scenario would allow the person leasing the home (tenant) to deduct the interest expense from their taxes. A percentage of lease payments go towards the down payment of the home if the option is exercised and the home purchased.
If your home is about to be foreclosed on, you have little incentive to offer buyers, but you could attempt to sell them on a modified lease option deal. The deal is similar to the one outlined above, with the exception that the investor owns the property and collects “rent.” A percentage of the tenant’s payment would go towards a down payment on the home, just as outlined above, giving the investor a small cash flow from your property. Set your option for 2-3 years and work like mad to fix your credit rating, then buy back your house at a better credit rating and lower monthly payment than your current ARM payment. From an investors standpoint, there is very little money to be made in doing deals like these, but there is some, none of which has to come out of the tenant’s pocket.
The deal, if possible, should be crafted so that the house sells to the investor for the remaining principal on the tenant’s loan and back to the tenant in a few years for the original principal remaining on the ARM loan before the home was sold to the investor. The sale price of the home should be adjusted slightly for appreciation when sold back to the tenant. This, hopefully, will preserve the equity in the home and allow for a smaller or now down payment to be made when transferring ownership from tenant to investor and back again to the tenant in 2-3 years. Don’t sign the papers on the deal unless you have already locked in how to get your house back without forfeiting your equity. I hope some of that makes sense.
The Truth of the Matter
The truth of the situation is that there are no easy solutions. From a owner and an investors standpoint, this one seems to be the most beneficial to both parties and the economy as a whole.
Risk- there would be a lot of risk in a deal like this. If your house is threatened by a foreclosure in the future, you are asking for goodwill and trust that you may or may not merit. Be ready to prove you’ll be able to handle the new payment.
Investors, a 6% / 30 year loan with a 15% down payment (there may already be equity in the home) on a $200,000 loan, holding appreciation at 1.5% and recouping that amount in the resale of the home to the original owner will produce a total return around 60%. The number sounds good, but amounts to a bit over $8000. The monthly savings to the tenant is $500 or more, or $18,000 over a three year ownership swap. The real savings is amplified further by splitting the appreciation on the home with the investor.
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