(Reprinted from the June 1998 issue of The Cash Flow Connection Newsletter. Please visit our online newsletter for more updated information including Selling Mortgage Notes – Where Have All the Simos Gone? Published November 2010)
With investors reporting over 40% of their new private mortgage purchases having less than 12 months seasoning, it’s no wonder the simultaneous close and working with realtors are some of the hottest marketing techniques. Perfecting the simultaneous close provides an alternative to conventional financing that can enable sellers to sell, buyers to buy, properties to move, realtors to earn, and investors to profit.
Working with the purchase of a private mortgage immediately following the real estate closing provides opportunities as well as challenges. Investors know that one essential component of the simultaneous close is maintaining it’s identity and distinction as a private purchase money mortgage. It is an alternative to lender financing not another form of a loan. Over the years elements have been identified that aid in maintaining this important distinction. A review of these may prove helpful for use in your own business activities.
1. Become familiar with basic residential mortgage lending requirements.
While traditional mortgage lending requirements do not typically apply to a seller financed purchase money mortgage or real estate contract, you should become familiar with them anyway. Why? First of all, this makes good marketing sense. How can you position seller financing as a great alternative to the traditional loan if you don’t understand how it works?
Secondly, it is essential to know what constitutes a loan and is subject to a variety of governing laws. Anyone in real estate investments should be aware of the number and brevity of regulations passed to protect the borrowing consumer. There are the Consumer Credit Protection Act of 1968, Truth in Lending (TIL), Regulation Z, Real Estate Settlement Procedures Act (RSPA), Home Mortgage Disclosure Act (HMDA), Usury, Mortgage Broker and Lender Licensing, and the list certainly goes on. It isn’t late night reading but become familiar enough with them that you can either 1) comply or 2) completely avoid any activity that falls under their application.
2. Substance Over Form
The substance of a seller financed real estate transaction and your level of involvement have a considerable impact on maintaining the purchase money distinction. It is important to remember that the seller is allowing the buyer to purchase the property by accepting a certain amount down and the remaining amount over time with payments of principal and interest. The consideration for the lien is the purchase of the property. The seller is the one extending credit by accepting installments on the sale, rather than a lender providing cash to the borrower for payment to the seller.
It is certainly appropriate for the seller to request a financial statement and a credit report from the buyer since they will be relying on their credit worthiness for payment. The form or authorization the seller utilizes should in no way reflect the lending of money. Once again the extension of credit is from the seller by accepting an installment sale.
Once the seller and buyer have agreed upon a price and terms of repayment an investor can provide a quote reflecting the amount they would be willing to invest or pay for the lien subsequent to closing. As an investor it is advisable that you don’t get involved in the actual negotiation of terms. Avoid determining such items as down payment, interest rate, and payment amount. Be certain that the real estate agent, seller, buyer, and closing agent, clearly recognize the difference between seller financing and a loan.
3. Your words say it all.
Loan is a four letter word. Abolish it from your private mortgage investment vocabulary and do not confuse the issue by using incorrect terminology. There are sellers not lenders, buyers not borrowers, investors not banks, seller financing or purchase money liens not loans, and never ever are there points, origination fees, or buy downs!
4. The Documents
It’s all in the details. The documentation that the closing agent prepares plays an important part in evidencing the items outlined in substance over form. As the potential investor, review them carefully to be sure they utilize the correct terminology. Be certain that the financing instrument clearly states it is a purchase money lien and names the seller as the mortgagee or beneficiary.
Pay particular attention to the closing statement. It is fairly common for the closing agent to use a HUD-1 Settlement Statement. This however is not a preferred closing statement for owner financing since it was primarily developed for traditional lender financing and is filled with inaccurate terminology. If your agent insists on using this form review it closely. Be sure they leave Section (F), Name of Lender, blank or put in the property seller’s name and address. Line 202, Principal Amount of New Loan, of Section J, should also be left completely blank. The agent should utilize an empty line in this section and entitle it seller carry back contract (deed of trust, or mortgage), purchase money lien, or something similar in order to correctly reflect the amount paid by buyer. Of course avoid all lending terminology including any items in Section 800, Items Payable in Connection With Loan. Again, the buyer shouldn’t be paying discount, origination fees, or any other items typically associated with a loan. If the buyer is paying for an appraisal or other item, have these listed in Section 1300, Additional Settlement Charges. These may seem like small items but again, it’s all in the details.
5. Doing it Right
In summary, if simultaneous closings are part of your investment portfolio, learn to clearly recognize and differentiate this product from a traditional residential real estate loan. If planning to originate loans, be confident you are aware of and comply with all regulations as well as licensing requirements. If working with both product lines, consider utilizing separate entities to conduct each business activity. It is certainly appropriate to obtain legal counsel on these issues and of course, as in all business transactions, treat people fairly, ethically, and with professionalism at all times.