The nationwide boom in "creative financing" of real estate has a negative side to it that homeowners, buyers and brokers ought to know more about.
The first sign of serious consumer abuses in creative financing are beginning to pop up, chiefly in California. But real estate and legal professionals across the country warn that problems are likely in most states within the next year unless consumers are better educated about the pitfalls of razzle-dazzle mortgage-making.
Creative financing in housing means nontraditional financing: wrap-around loans, seller "take-backs" of first and second mortgages, contracts-for-deed, assumptions of existing loans and a long list of other approaches. The key to all of them is that they sidestep the high interest rates and tough loan terms imposed on buyers by institutional lenders like banks and savings and loan associations.
They also usually involve the seller of a house far more deeply in the transaction than do traditional mortgage methods. Sellers commonly defer a portion of their sale proceeds for three to five years and accept small down payments to make the deal go.
Although creative techniques accounted for barely 5 percent of home sales in the United States as recently as 1979, they now are being used in 50 percent of all residential transactions, according to data compiled by the National Association of Realtors. Inm southern California the estimate is even higher: Seven out of 10 home sales in 1981 involve some form of seller participation in the financing arrangements.
The boom in creative real estate financing isn't a problem per se. Properly structured with professional help, most of the techniques represent safe, sound answers to the needs of sellers and buyers.
Improperly structured, though, creative techniques can be financial time bombs ticking away for the people who use them.
Probably the biggest area of abuse concerns creative sales agreements that are skewed heavily in the buyers' favor. Homeowners who are frustrated after months of unsuccessfully trying to sell their property are turning into easy prey for sharp, bargain-hunting buyers.
For example, after investigating a rash of "no-money-down" transactions in the Los Angeles area, a spokesman for the California Department of Real Estate described them as "ripoffs, pure and simple."
In one case a home seller agreed to accept only a promissory note as a down payment from the purchaser of his house, rather than cash. The note was secured by a second deed-of-trust against another house owned by the purchaser. Unfortunately, the buyer's house had more notes against it than it had equity, rendering the market value of the down payment note virtually nil.
Some creative buyers in California are even taking the "no-money-down" technique one step further: They're actually walking away from transactions with thousands of dollars in their pockets.
Chuck Lamb, a real estate broker in suburban Northridge outside of Los Angeles, says he's now seeing "five to 10 of these crazy deals every week -- offered to sellers by people who think they can collect houses for nothing."
In a typical arrangement, according to Lamb, the buyer agrees to pay the home sellers' full price and goes out and obtains a conventional 80 percent loan from a bank or S&L.
The seller, however, also agrees to take back a large second deed-of-trust secured by the house, which isn't recorded until after the escrow or settlement is completed. The combined value of the two loans against the property -- the bank's first deed of trust and the seller's second -- equals 130 to 140 percent of the true market value of the house.
The seller writes a check for $10,000 or $20,000 out of the lender's cash and gives it to the buyer, who pockets it. Nobody ever informs the bank or S&L. The buyer rents out the house, and the seller prays for eventual full payment.
The buyer in this case has little to prevent him from walking away with the cash if he chooses to. He's invested nothing in the deal and already has made money.
The seller -- who mistakenly went along with a contract promising a high price and quick sale for his house -- stands to lose plenty if the buyer defaults.
The bank will come after the house to recover its funds. If anything is left over from the foreclosure, the seller -- who's holding the second deed-of-trust -- will get some of it. But it won't be anything like the face value of the note.
"It's the funny-money real estate game," said Lamb, "And it's spreading fast.