What is a creative home loan?

Answer 1

When someone wants to buy a home, but they are unable to gather enough money to pay for it (cash for equity + loan proceeds), then the buyer and seller are going to have to get "creative" if they are going to be able to close the transaction. Unfortunately, getting "creative" sometimes means being subversive. A common example is the wrap-around mortgage when the seller's mortgage has a "Due On Sale" clause. With this clause, the buyer will not be allowed to assume the mortgage, but must get a new loan. The seller is supposed to pay off the old loan. But, let's say the buyer is not able to qualify for a new loan and the seller is willing to try to keep any knowledge of the sale from his lender. Let's say the seller's loan is at a low interest rate of 5% and has a current balance of $80,000. The seller might agree to sell the house to the buyer for $100,000. The seller accepts a note from the buyer (a loan) for the purchase price of $100,000 (nothing down) with an interest rate of 8%. Each month, the buyer pays the seller who in turn, sends part of the money to his mortgage company as payment on the original loan. To make sure the seller keeps making payments on his loan, the buyer often insists on making payment to an escrow company (or attorney) who will forward a portion to the original lender as a loan payment and remit the balance to the seller. The buyer gets a house he cannot otherwise obtain. The seller has actually made a loan of $20,000 to the buyer (the seller's equity in the property was loaned to the buyer, since there was no cash downpayment). But what does the seller earn on that $20,000 loan? First, he receives 8% interest on $100k each year. That's $8,000 per year. Second, he has to pay 5% on the $80k he owes. That's $4,000 per year. So, the seller is NETTING $4,000 (8 - 4 = 4) per year that he gets to keep. That is a 20% rate of return on his $20,000 loan to the buyer. That's a creative home loan. There are other ways to be creative -- such as obtaining a lease with an option to buy (where the tenant gets credit for part of the rent toward the purchase price).