In the ongoing effort to structure more profitable deals, both buyers and sellers are often lured into transactions which are implausible if not unworkable. Many of these arrangements are described in glowing terms as "too good to be true," a phrase which is literally correct in too many instances.
Different arrangements work for different buyers and sellers and so with the exception of fraudulent transactions there are few strategies which are not right for someone. The problem is that a given strategy which is "right" for one person may be "wrong" for a multitude of others. Here are three situations to consider, arrangements which may be ruinous unless fully understood and reviewed with great care.
* The Cash-Plus Sale. In this situation a buyer offers to purchase property for a premium recorded price. If a home is being marketed for $150,000, a buyer might offer $195,000 in a deal that works like this: the buyer will get a $120,000 first trust and the seller will hold a $75,000 second trust. Of this amount the seller will receive $75,000 in cash from the proceeds of the first trust and $75,000 in the form of the second trust for a total of $150,000. The buyer will get title to the property plus $45,000 in cash.
It would seem that the seller should be happy with this arrangement since the entire asking price has been received, at least on paper. However, what has really happened is that the buyer has paid nothing for the property but wound up with $45,000 in hand. If the buyer defaults on the first trust, the owner-turned-lender will have a second trust note with little if any value. While it may be possible for the seller to pursue a buyer to settle a second trust claim, litigation may be costly, time-consuming and possibly ineffective in the case of a buyer without the means to pay.
* The No-Cash Deal. There have been millions of homes which have been purchased with no money down, including a large percentage of sales to veterans. No money down means that buyers are getting the largest possible loan for a property, an arrangement that will also produce the largest possible monthly mortgage cost. While VA buyers must be economically qualified before they can get 100 percent financing, purchasers who receive private mortgages may not be held to the same standard of financial responsibility.
In a no-cash deal, for example, the buyer may purchase a home for $100,000 by assuming an existing loan with a $65,000 principal balance and getting a second trust from the seller for $35,000 and further cutting expenses by having the seller pay all settlement costs.
Without a second party such as the VA to provide certain guarantees, the lenders in a no-cash deal assume all the risk of the transaction. This can make sense with a well-qualified, responsible purchaser. However, in the case of a buyer who has few assets and an aversion to financial planning, a no-cash deal may result in missed monthly payments, foreclosure and little, if any, protection for the second trust holder.
* Unrecorded Sales. It sometimes happens that a home is sold with a loan that cannot be assumed but where the buyer and seller agree not to record the deal or notify the mortgage holder of the transaction. The seller in such cases continues to make monthly mortgage payments to the original lender while the buyer, in turn, pays the seller on a monthly basis. The buyer gets to record title when interest rates drop and the property can be refinanced or when the debt to the seller is paid off.
This arrangement, which is often called a "land contract," "installment contract," "contract for deed" or a "conditional sales agreement," raises a number of serious issues. What happens if the seller misses a payment to the lender? What if the lender finds out about the deal? What are the rights of the buyer if he or she misses a payment to the seller? If the property burns down, who gets the insurance money?
Land contracts are not for the average buyer or seller. In those situations where the loan is assumable, it would seem to make far more sense for the buyer to assume the loan, get a second trust from the seller and record the entire transaction to assure that all legal and equitable rights have been fully protected. If the original loan is not assumable then one has to ask if the purpose of an unrecorded transaction is to deny the contract rights of a lender.
While all financial arrangements have the possibility of working, some are less plausible than others. For both buyers and sellers, innovation must be tempered with common sense and the recognition that the circumstances which make an arrangement worthwhile in one deal may not apply to different transactions. NEXT WEEK: Assumptions