The nationwide surge in so-called "creative financing" techniques for credit-strapped home buyers and sellers is producing new sets of risks for unwary consumers and their real estate brokers.
Owner-financing arrangements, second mortgages and deeds of trust, contracts-for-deed and a host of other techniques designed to sidestep current high interest rates can be superb ways to buy or sell a home this spring. But they can also be quick routes to a lawsuit, foreclosures by banks or savings and loan associations, and produce big dollar losses for consumers.
Creative financing -- which economists for the National Association of Realtors say accounts for between 30 and 80 percent of current home sales in major U.S. markets -- minimizes reliance by the buyer and seller on traditional mortgage lending sources.
The most common methods range from simple assumptions of sellers' existing low interest rate mortgages by buyers to more complex forms of direct financing of the buyer by the seller. Usually the latter techniques put the home seller into the position of a bank -- making a loan to the buyer from the anticipated proceeds of the sales price of the house.
The problem with creative financing, according to legal and real estate authorities active in the market, is that in the wrong hands, it can be far more dangerous than most consumers understand.
The custom-tailored nature of many of these techniques "tends to eliminate the automatic statutory consumer protections built into the standard forms of real estate transactions," in the words of Robert Porter, president of Pacific West Mortgage and Escrow Co. of Seattle.
Home sale transactions by people unfamiliar with state and federal lending laws "can lead to some very nasty situations where sellers or buyers are breaking the law, or exposing themselves to later legal attacks by lenders or by each other," Porter says.
States with usury limits, for example, present potential challenges to creative financing. Although Congress has overridden state interest rate ceilings as they apply to most conventional lenders through April 1, those usury limits remain in force for individuals making real estate loans.
A home seller in New Jersey who provides a buyer with a first mortgage carrying a rate of more than 10-1/2 percent -- in a market where the prevailing rates are actually about 15 percent -- violates the state usury law. An individual seller in the state of Washington can't charge above 12 percent. In Missouri the ceiling is 12.8 percent.
Usury limits may be gone for institutional lenders around the U.S., but they're very much in force for individuals in more than 18 states.
Creative real estate transactions can produce devastating legal effects when they trigger foreclosure actions from professional lenders. A case in point occurred in Northern Virginia last week, when a court upheld a savings and loan association's foreclosure against a husband and wife who sold their suburban town house using an installment sales contract.
The sales contract they used, known technically as a contract-for-deed or land contract, permitted their buyers to effectively assume their two-year-old, 9-1/2 percent conventional mortgage, despite standard language in the mortgage prohibiting an assumption.
The S&L found out about the contract-for-deed only when the new buyer's name appeared as the beneficiary on the property hazard insurance policy in the loan file. It wanted to "accelerate" the rate on the mortgage -- move it up from 9-1/2 percent to the prevailing market rate -- but the new buyer resisted. The S&L put the town house up for foreclosure sale and the case went to court.
Lenders in some parts of the country don't object to contract-for-deed, since legal title to the property involved doesn't pass immediately to the new buyers. But in a large number of others, like Virginia, they're on the lookout for them in 1980, and plan to foreclose when they find them. Neither buyers nor sellers should enter into one of these contracts -- in any state -- without experienced legal advice in advance.
Another increasingly popular technique known as the "wraparound" mortgage or deed of trust also is triggering a wave of court actions in some states. Wraparound loans involve assumptions of existing loans plus provision of a secondary loan from secondary loan from seller to buyer, usually at favorable interest rates and terms. The seller continues to pay off the original mortgage, but the buyer is actually providing the money, living in the home, and has the deed.
When the underlying loan is not assumable, but legal title to the property has passed to a new owner, the lender has never even heard of -- much less examined for credit-worthiness -- most lenders hit the ceiling.
Creative financing, in short, may just be what you need to solve your real estate problems in a tight market like today's. But use the techniques with knowledge of their inherent risks, and get help from an attorney who knows the ins and outs of state and local law.