The custom-tailored "creative" note you've just signed to buy a house could turn into a financial albatross around your neck three to five years from now -- unless you received professional help in putting the transaction together.
That's the blunt warning from a growing number of real estate attorneys, consumer protection authorities and state regulators around the country.
With so-called creative financing techniques now accounting for more than 50 percent of all 1981 home resales in many parts of the United States, experts predict that foreclosures and legal battles are virtually certain to increase sharply in the next several years.
"There's no question we're going to see fallout" from the 1981 creative-financing boom, says a spokesman for the California Department of Real Estate.
"It's going to be in the courts, it's going to affect professional lenders who should have known better, and it's going to hurt some innocent buyers and sellers."
Already the department has issued warnings to real estate brokers in the state to steer clear of some of the hypercreative "no money down" home purchase techniques -- particularly those in which a buyer offers only promissory notes or deeds of trust as down payment for the property.
In several cases documented by the department and realty groups in the Los Angeles area, buyers have actually persuaded home sellers to give them cash -- a reverse down payment, in effect -- in exchange for a high price for the house and an immediate sales contract. The sellers have handed over thousands of dollars of bank loan proceeds to the purchasers following the close of escrow or settlement on the sales.
The buyers, for their part of the bargain, have signed second and third deed-of-trust notes whose ace amounts total more than the appraised resale value of the house, but that have almost no real market value. The sellers have parted with their house and cash, in short, and have been left with a handful of paper promises.
Although the "no money down" techniques have been most popular on the West Coast, lawyers and state real estate regulators in the East, South and Midwest say that even the less creative forms of seller financing can produce significant problems.
Benny L. Kass, a Washington real estate attorney and consumer protection columnist, ranks short-term "baloon payment" mortgages or deeds of trust between sellers and buyers as one of the top potential areas for future trouble.
"Balloon" mortgage plans require a lump-sum final payment at the end of the loan term, often representing 75 to 95 percent of the total principal debt. If the full amount isn't paid, and the lender of the money won't go along with an extension of the payment schedule, the homeowner is subject to foreclosure and may lose his or her house.
Short-term, three- to five-year balloon plans -- which were the predominant form of real estate financing prior to the Great Depression -- are legal in most states, and are one of the most common forms of seller-financing in the United States. They can be second deeds of trust or mortgages ("purchase money" seconds designed to cut the down payment requirements of a buyer), or first mortgages, where the home seller functions as the bank.
Kass says he's constantly amazed at the purchase contracts he sees containing terms that are unnecessarily disadvantageous to the buyer or seller.
Buyers who can only qualify to purchase a house at an interest rate of 11 percent -- and who sign up for a one- or two-year seller-financing balloon mortgage at that rate, "tie themselves and their families to a potential financial time bomb, Kass believes.
"What happens if interest rates are much worse, not better, when the balloon comes due?" he asks. "What happens if the buyers' income doesn't increase appreciably and they can't qualify for a conventional loan from an S&L or bank? They go down the tubes -- that's what."
Kass urges that at the very least, such loans contain a "safety net" clause for the buyer, guaranteeing an extension of the loan for a mutually agreeable period if conventional interest rates haven't dropped to a level the buyer can afford during the initial term of the mortgage.
If interest rates stay above 14 percent in the conventional market, for example, a three-year balloon note might contain a mandatory one- or two-year extension period at the original rate.
During the extension period, the buyer would be required to refinance whenever conventional rates dropped below 14 percent. Once the extension was up, the note would be due -- with no further extension -- and the buyers would have to "sink or swim," Kass contends. Presumably, though, the extra time on the note would have given the borrowers breathing space, and the opportunity to qualify for higher rates with higher incomes.
Sellers might not like safety-net clauses in their mortgages, but Kass recommends that buyers refuse to sign up for balloon payment deals without them.
"The risk is too great," he says, "and you end up in foreclosure or lawsuits, and nobody's happy but the lawyers."