Transcript Chapter 11

REF Presentation 7
Chaps 11 & 12
Government Programs:
FHA and VA Loans
I. Federal Housing
Administration
II. Aka F.H.A. (TQ)
Federal Housing Administration
 The Federal Housing Administration (FHA) was
created by Congress in 1934 as part of the
NATIONAL HOUSING ACT.
 The FHA’s primary function is to insure loans. FHA
approved lenders are insured against losses caused
by borrower default. (TQ=INSURE LOANS NOT BUY
LOANS OR SELL LOANS ETC.)
 As the insurer, the FHA incurs full liability for losses
resulting from default and property foreclosure.
 The FHA insurance program is called the Mutual
Mortgage Insurance Plan ( MMI).
Housing and Economic Recovery
Act of 2008
 Enacted July 30,2008, this act was passed by
the U.S. Congress to primarily address the
subprime mortgage crisis. The law is in effect
until September 30, 2011.
 Summary of Act:
– Increases the FHA loan limit from 95% to 110% of area median
home price up to 150% of the GSE conforming loan limit, or
$625,000
– Requires a down payment of at least 3.5% (TQ)
– Places a 12 month moratorium on HUD implementation of riskbased premiums (ALREADY EXPIRED SEE NEXT SLIDE)
– Prohibits seller-financed down payments
– Allows down payment assistance from family members
M.I.P. RULES (TQ whole slide!!)
 BASIC RULES FOR MINIMUM DOWN
LOANS (PURCHASE) 30 YR LOAN
– MIN DOWN MIP = 1 % UFMIP (Up Front Mtg. Ins. Premium –
added to base loan), SO IF LOAN IS $100,000…you add $1000 to
the loan)
– MONTHLY MIP = .9 % / YEAR / MONTH (so .9% x total loan
amount divided by 12 added to each payment
 This has the effect of have .9 (almost 1) % added to your interest rate
 This is all lenders a national program not optional
A. FHA LOAN FEATURES
 Any loan intended for submission for FHA insurance
has a number of features that distinguishes it from a
conventional loan. The most significant of these
features are:
1. Less stringent qualifying standards. TQ
2. Low down payment. TQ
3. No secondary financing is allowed for the down payment. TQ
4. Some closing costs may cover down payment. TQ
5. FHA mortgage insurance is required for the loan regardless of the
amount of the down payment. TQ
6. No prepayment penalties are allowed. TQ
7. The property must be owner-occupied. TQ
B. OTHER CHARACTERISTICS OF FHA
LOANS
 The typical FHA loan has a 15 and 30-year terms.
 The FHA requires their loans to have a first lien position.
 A lender may only charge a 1% origination fee on an FHA loan,
but is allowed to charge discount points. TQ
 The lender is required to obtain an appraisal of the property from
an FHA approved appraiser. TQ
 Unlike many conventional loans, FHA loans are fully assumable
without any increase in interest rates. REQUIRES FULL
QUALIFICATION INCLUDING APPRAISAL AND CREDIT. SEE
ADDITIONAL SLIDE (TQ)
 A lender is also prohibited from exercising any “due on sale”
clause on an FHA transfer.
 FHA loans are not assumable by investors.
ASSUMABILITY FHA – TQ’S
 Same rules as established in 1989
–
–
–
–
Buyer must qualify
Seller will want their equity
No investors (owner occupied only)
Assumption will be through seller’s existing lender not a
new lender
 Advantage, if rate on seller’s loan is lower than
market
 Disadvantage, if buyer can’t quality anyway it
doesn’t matter; no “break” for buyer
 More details to be discussed in break out session
if desired
C. INCOME QUALIFICATIONS AND
MAXIMUM LOAN AMOUNTS
 There is no minimum (DOLLAR AMT) income
requirement for an FHA loan, BUT they must qualify
for loan payment as usual TQ
 Borrowers must show two years of steady
employment and demonstrate that they have
consistently paid their bills on time. TQ
 The FHA has a ratio of 29% and 41%. This means
that the payments for a home loan may not exceed
29% of the borrower’s gross monthly income and all
installment debt, including the home loan payment,
may not exceed 41%.
 These amounts, which vary by state as well as
location within a state, are adjusted yearly.
FHA QUALIFICATION RULES
 DEBT RATIOS OF 29% / 41% ARE NOT
“SET IN STONE”
– THE RULES ARE FLEXIBLE AS LONG AS
THEY MAKE SENSE TQ
– THE PROGRAM IS DESIGNED FOR BUYERS
TO GET HOMES TO LIVE IN AND NOT TO
“SAY NO!” TO BUYERS
 of course not everyone gets approved
 it’s just better that’s all
D. MUTUAL MORTGAGE INSURANCE
(MMI) DROP OFF RULE
 THE BOOKS MMI RULES ARE THE OLD RULES SEE
PREVIOUS MMI SLIDE!!! **** TQ TQ
– When the loan balance drops below 78% of the original
purchase price, the monthly payment will automatically be
cancelled, provided the borrower has made monthly
payments for five years on a thirty-year mortgage.
– Other common sense rules apply, like your payments should
be on time….”DUH!”
HOPE for Homeowners
 When the subprime mortgage crisis reached
its peak in the fall of 2008, the federal
government took steps to help stabilize the
American housing market.
 The Emergency Economic Stabilization Act
of 2008 was signed into law on October
3,2008.
 Named the HOPE for Homeowners Act, this
new law is designed to prevent qualified
home owners from defaulting on their loans
HOPE, IT WORKS….
 IF YOU NEED IT
 YOU ARE IN THE 10 % TO 20 %
 THAT GET APPROVED
– AKA “LOAN MODIFICATION”
– DON’T PAY ANYONE TO DO THIS YOU CAN
AND SHOUD DO IT!! TQ
A. FHA 203b FIXED RATE PROGRAM
 With a 203b FIXED RATE PROGRAM, a down payment of 3.5% of
the sales price is required.
 Gifts from family members are allowed, as are payments from
government or non-profit agencies that are designed to help first
time or low income buyers.
 FHA does not require the borrower to have cash reserves.
 2 years of employment prior to application is required.
 All owner occupied one-to-four unit family residences are eligible.
 A REALLY GOOD PROGRAM AS LONG AS YOU FOLLOW THE
RULES….IT’S THE GOVERNMENT IF YOU DO THIS THEN BE
PATIENT, PATIENT, PATIENT TQ TQ TQ!!
B. FHA 251 ADJUSTABLE
PROGRAM
 The FHA 251 ADJUSTABLE PROGRAM is a thirty-year adjustable
rate mortgage.
 It is indexed to the one-year Treasury Bill rate and is adjusted
annually.
 The adjusted rate may not move higher or lower than 1% per
year. The rate is capped at 5%.
 Eligible property types, mortgage insurance premiums, closing
costs rules, down payment requirements, and qualifying ratios are
the same as for the 203b program.
 IF RATES WERE LOWER FOR THESE THAN THE FIXED BY ABOUT
1% START RATE THEN IT WOULD BE A GOOD OPTION….OTHER
ISSUES COULD MAKE IT BETTER. TQ
 If you know your going to move or retire and move, etc. in 2 or 3
years and rates were good it could be a good option. FOR NOW
THOUGH FIXED IS IT!!! TQ
C. FHA 203k PURCHASE AND
REHABILITATION PROGRAM

The FHA 203k PURCHASE AND REHABILITATION PROGRAM was developed
to help revitalize communities and neighborhoods.

Normally, in conventional practice, a homebuyer must first purchase the
home and then obtain construction financing to rehabilitate the home.

The 203k program permits a borrower to obtain a property in need of
rehabilitation with just one loan. TQ

The program allows loans on one-to-four unit family dwellings that are at
least one- year old.
The 203k program also allows loans on mixed use properties. A MIXED USE
PROPERTY combines a single-family residence with a commercial building.


A 203k loan has a minimum requirement of $5,000 in needed repairs that
cover the health and safety of the occupants. TQ
1. Steps in the 203k Program
 First, after locating a prospective property, the buyer and
his or her real estate agent make a preliminary analysis
of the extent of repairs necessary and a rough estimate
of the cost of the work to be carried out. Up to $35,000
TQ…
 Then a sales contract is executed, including provisions
that the borrower has applied for 203k financing and that
the contract is contingent upon approval of this financing.
 The buyer then contacts an approved FHA lender.
 The lender will, at this stage, recommend an FHAapproved 203k consultant (generally a contractor) to help
the buyer draw up the necessary work write-ups and cost
estimates.
 The appraiser will then carry out an (2) appraisals of the
property. One as is, one as it will be. TQ
203k (cont.)
 FHA then issues a mortgage insurance certificate to the
lender.
 Repair work may begin at the time of closing and must
be completed within six months.
 The repair funds are disbursed as each stage of
rehabilitation is completed.
 Upon overall completion, a final inspection is carried out
by the FHA-approved inspector. TQ…
 The mortgage will then close and the lender will submit
the closing documents to FHA.
 The lender will review the application and issue a
conditional commitment and statement of appraised
value.
D. FHA TITLE I PROGRAM
 The FHA TITLE I PROGRAM is designed to
allow homeowners to finance light repairs or
permanent improvements to their homes.
 Loans of up to $25,000.00 will be insured for
a maximum of twenty-five years.
 The borrower also pays a mortgage insurance
premium for a Title I loan.
Title 1 Loans are currently
not in play. The program
does still exist, there just
aren’t any lenders in the
game right now TQ!
III. VA Loan Guaranties
NEXT!!!
VA Loan Guaranties*
 In 1944, a grateful U.S. Congress passed the
Serviceman’s Readjustment Act to provide returning
World War II veterans with education, medical, and
home loan benefits to help them readjust to civilian
life.
 This law is often referred to as the G.I. BILL. TQ
 Veteran’s benefits are managed by the DEPARTMENT
OF VETERANS AFFAIRS (VA).
 One very important benefit is the VA home loan
guaranty**. The difference between FHA is that VA
is a “gaurantee” of a portion of the loan, not
mortgage insurance of the whole loan amount. TQTQ
A. VA LOAN GUARANTY
CHARACTERISTICS
 The VA program has a
number of features
that are attractive to
borrowers who qualify:
1. A VA loan may not have
prepayment penalties.
2. A VA loan may be assumed
by anyone; the new buyer
does not have to be a
veteran.
3. No mortgage insurance is
required.
4. Funding fees may be
financed.
5. Builder warranty is required
on new homes.
6. Closing costs may be paid by
seller.
 Current closing cost items
include:
1. A maximum 1% origination fee.
2. Appraisal fees are set by Regional VA
offices. The fee may not be more than
is reasonable and customary for the
area.
3. Credit report fees may not exceed the
cost charged to the lender. Credit
research fees of $50.00 charged by
Loan Prospector® are allowed.
4. The veteran may pay for hazard and
flood insurance, if required.
5. The veteran may pay for title insurance.
6. The veteran must pay the VA funding
fee.
7. The veteran may pay for recording fees.
8. The veteran is responsible for prorated
interest and property taxes.
1. Sale by Assumption

Veterans who obtain loans guaranteed by the VA are legally obligated to
indemnify (pay back) the United States government for any claim paid
out by the VA under the loan guaranty. TQ (Makes VA loans less popular
than the FHA for assumptions.) TQ

To facilitate a veteran’s release from liability on a loan a new buyer
intends to assume, it is best to include in the sales contract a provision
to that effect.

The sales agreement should provide that the buyer will assume all the
seller’s loan obligations, including the liability for indemnity on the VA
loan, and that the sale will not be closed unless and until the VA
approves the credit and income of the purchaser.

The seller must apply to the VA for a formal release of liability.

If the sale closes without first obtaining the release from the VA, the
veteran will find that he or she is fully liable in the case of a default.
2. Restoration of Entitlement
 A veteran who has paid off his or her loan, and sold the house on
which the loan was secured, may have all his or her entitlement
restored. TQ
 ENTITLEMENT is the maximum insurance amount that the VA will
provide for the veteran’s home loan.
 By act of Congress, the veteran is entitled to the amount by
virtue of his or her service in the armed forces.
 Entitlement may also be restored if the property is sold to
another veteran who substitutes his or her entitlement for the
seller’s.
 To restore entitlement, the veteran must apply to the VA and fill
out the necessary forms.
3. Eligibility
 Eligibility requirements for a VA loan vary depending on
when and where a veteran served and the length of the
service.
 In general, the periods for active wartime service are:
 WWII 09/16/40 - 07/25/47
 Korean Conflict 06/27/50 - 01/31/55
 Vietnam Era 08/05/64 - 05/07/75
 Persian Gulf War 08/02/90-TBD
 Peacetime veterans are also eligible for the
periods:
 07/26/47 to 06/26/50
 02/01/55 to 08/04/64
 05/08/75 to 09/07/80 (enlisted) 10/16/81 (officer)
VA ELIGIBILITY CONT #1
 THE MAIN POINT TO UNDERSTAND ON V.A.
LOANS AND THE ELIGIBILITY IS THAT IT
DEPENDS WHEN YOU SERVED IN THE
MILITARY, WHAT DATES, POSSIBLY WERE YOU
IN A WAR ZONE AND SO ON….IT ISEEMS
ESSENTIALLY FAIR….SO THE DATES OF
SERVICE ARE ON YOUR DISCHARGE THE “DD214” THE MILITARY LOVES THEIR NUMBERED
AND ACRONYMED PAPERWORK; SOME DAY IT
WILL MAKE SENSE (POSSIBLY TO YOU!!!) TQ
TQ
Eligibility (cont.)
 Selected reserves and National Guard are eligible
after six years of service.
 Members of the military who have served in Iraq and
Afghanistan or are currently serving are eligible for all
benefits.
 The spouse of a serviceperson who died while in
service.
 Lastly, Public Health Service officers, cadets at the
service academies, some merchant seamen of WWII,
and officers of the National Oceanic and Atmospheric
Administration may be eligible as well.
4. VA Loan Guaranty Amounts
 The VA does not guarantee the entire amount of a loan. TQ
 A veteran’s maximum entitlement is currently $36,000.TQ TQ
 This may be adjusted upwards on certain loans.

On October 10, 2008 the President signed the VETERANS BENEFITS
IMPROVEMENT ACT OF 2008
 The following are highlights of the changes to the
program:
1. Authority to guarantee adjustable rate mortgages and hybrid ARMs has been
extended through 9-30-2012
2. Refinance loans are available for up to 100% of the appraised value of a
home rather than the previous 89%
3. Guaranty amounts for loans of $417,000 or less are unaffected
4. On loans for more than $417,000, the VA will guarantee 25% of the original
loan amount up to a maximum guaranty
5. Partial Entitlement
 A veteran who used his entitlement to
purchase a home in the past may use
that portion of his remaining entitlement
to purchase a second home. TQ
 EXPLAIN SCENARIO…..
 Example:
A veteran used the maximum entitlement of
$25,000 that was available in 1978 to purchase a
home. Today, he wishes to purchase a second
vacation home. The home is priced at $100,000.
The veteran has $11,000 remaining in entitlement
($36,000 - $25,000 = $11,000).
B. THE VA LOAN PROCESS
 The first step in the process is to determine if the
veteran has a Certificate of Eligibility which was given
to him/her as part of their discharge papers.
 A CERTIFICATE OF ELIGIBILITY notifies the
lender that the veteran is eligible for a VA loan and
what his or her entitlement will be.
 All lenders are responsible for conforming in full to VA
requirements. TQ (many times the loan officer goes
to get the paperwork for their client.) Public
Information TQ TQ
 This includes the use of VA-approved appraisers and
underwriters.
IV. CHAPTER SUMMARY
 The FHA and VA loan programs are huge federal insurance
programs that are backed by the full faith and credit of the U.S.
Government. TQ
 The FHA has been a boon to the lending, construction, and real
estate markets since its beginning.
 MMI TQ
 Additional Programs (203b, 251, 203k)
 Title I
 The VA programs are designed to provide veterans returning to
civilian life an opportunity to enjoy the benefits of home ownership.





No prepayment penalties
No mortgage insurance
Liable to U.S. Gov’t (Indemnity)
Assumable
Entitlement/Partial Entitlement
Seller Financing
Which lenders do seller
financing?
Trick Question!
NONE! TQ
Seller Financing
 In tight money markets, it’s not uncommon for a
seller to make a deal to finance part of the purchase
price. TQ
 Mortgage money from traditional lenders may be too
costly in terms of interest rates, or simply
unavailable.
 Buyers may be unable to come up with the
necessary cash for the down payment required by a
conventional mortgage, or simply wish to take
advantage of the low interest rate on the seller’s
existing mortgage.
 In any case, sellers can often enhance the salability
of their properties by offering financing in the form
of purchase money mortgages or land contracts. TQ
I. Purchase Money
Mortgage/Trust Deed
 A PURCHASE MONEY MORTGAGE is given by a buyer
to a seller to finance the purchase.
 The seller is the MORTGAGEE or BENEFICIARY. TQ
 The advantage of this arrangement is that sellers are not
bound by institutional policies regarding loan ratios,
interest rates, or qualifying standards. (THEY CAN MAKE
THEIR OWN U/W DECISION). TQ
 The seller is taking a risk with a purchase money
mortgage, but it may be justified if it allows the sale to
proceed or enables the seller to get a higher price for his
or her home.
 Because the profit from the sale is spread over several
years, the seller may benefit from a lower rate of income
taxation.
A. UNENCUMBERED PROPERTY
(THE BEST SCENARIO – TQ)
 FREE & CLEAR
– The simplest form of purchase money financing is where the
seller has clear title to the property, free of any mortgages
or other liens.
– The buyer and seller simply negotiate the amount and terms
of their financing arrangement and draw up the appropriate
documents.
 Purchase money financing may take any of the many
forms discussed in earlier chapters, such as variable
interest rates, graduated payments, or partial
amortization with balloon payment.
 Virtually the only limit is the imagination of the parties &
the legality & title insurability of the transaction.
 Example:
– Grandma Perkins decides to move to her sister’s farm in
the country and wants to sell her townhouse. The
mortgage on the townhouse has long since been paid.
Mr. and Mrs. Jenkins want to buy the townhouse, but
cannot qualify for conventional financing. However,
Grandma believes they are honest and reliable people
who can be trusted to pay off a loan, so she offers them
the following deal: sales price of $90,000, with $8,000
down and the balance in the form of a purchase money
loan, secured by deed of trust with Grandma as the
beneficiary. Interest will accrue at the rate of 6% for the
first year, and increase ½ of 1% per year until it reaches
7.5%, where it will stay for the balance of the 30-year
loan term. Payments are to be interest only for the first
six years, and the principal then fully amortized over the
balance of the term.
B. ENCUMBERED PROPERTY
 Because many residential properties are
encumbered by existing mortgages or deeds
of trust, seller financing often involves
assumption or refinancing of existing debt.
1. Assumption
 If the seller’s existing mortgage does not contain an
alienation clause (due-on-sale clause), it is
assumable. TQ
 The buyer can simply agree to take over payment of
the seller’s debt with the terms of the note
unchanged.
 The property still serves as the basic security for the
loan, but the buyer becomes primarily liable for
repayment of the debt.
2. Assumption and Release
 An assumption can take two forms.
 In the first case, it is an agreement strictly between
the buyer and seller. The buyer assumes liability for
the loan, but the seller is not completely released
from responsibility; he or she remains secondarily
liable.
 In order for the seller to be relieved of this
responsibility, he or she must obtain a release from
the lender.
3. Alienation Clause
 The seller’s existing mortgage may contain an
ALIENATION CLAUSE, which is designed to restrict
the seller’s right to transfer the property.
 The clause may be triggered by the transfer of title or
by the transfer of significant interest in the property
(e.g., a long-term lease).
 The alienation clause may give the lender the right to
declare the entire loan balance immediately due and
payable, the right to raise the interest rate on the
loan, or the right to do either at its option.
C. PURCHASE MONEY SECOND
MORTGAGE
 If the buyer does not have sufficient cash to cover the
difference between the sales price and the institutional
financing, a purchase money second mortgage can be the
key to closing the sale. TQ (riskier for the seller!)
 Seller-sponsored second mortgages are subject to the
same lien priority rules as institutional mortgages.
 In the event of default and foreclosure, the first mortgage
is paid in full from the proceeds of sale before any
proceeds are allocated to the second mortgage.
 Sellers who take back second mortgages should keep this
in mind when negotiating the amount of seller financing.
D. SELLER-SPONSORED
WRAP-AROUND FINANCING
 The WRAPAROUND MORTGAGE is a loan
transaction in which the lender assumes
responsibility for an existing mortgage.
 The “wrap” is sometimes used to get around
the provisions of an alienation clause (which
limits the ability to assume a loan).
 The attractiveness of the wrap-around is that
it enables the buyer to obtain financing at
below market interest rates while still
providing a market rate of return for the
seller.
E. WRAP-AROUND VS. ASSUMPTION
PLUS SELLER SECOND
 In an assumption, the buyer receives the
benefit of an existing low interest rate loan.
 If the transaction is structured with a wraparound loan at market rates, the seller
receives the benefit of the existing low interest
rate loan and is able to receive a very
attractive rate of return on the portion of the
financing that is actually extended by the
seller.
 A wrap-around transaction can also be
structured so that the seller receives above
market rates on the credit actually extended
and, at the same time, the buyer pays below
market rates on the total amount financed.
F. RESALE OF PURCHASE MONEY
SECURITIES
 If a seller wants the option of cashing out at some time in
the future, he or she can do so without giving up the ability
to offer purchase money financing.
 If the seller desires to resell his or her loan immediately or
in the future, the seller should use standard Fannie Mae
forms for writing the financing agreement with the buyer.
 The seller then has the option, at any time, of ordering the
approved lender to pass the loan through to Fannie Mae,
thereby cashing out the seller.
 DO NOT ASSUME THE ABOVE IS CORRECT
TQ TQ
II. Land Contract
 Usually used to sell…..LAND! TQ
 In some areas, a popular form of purchase money
financing is the land contract.
 The distinguishing feature of a land contract is that the
seller retains legal title to the property until the buyer has
made all of the payments on the contract.
Land Contract
SEE THE CONTRACT CAN BE SIMPLE….TQ, BUT PROBABLY
WON’T BE!! TQ
A. CONTRACT SUBJECT TO EXISTING
MORTGAGE

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
It is rare to find a seller whose property is not encumbered by some form
of mortgage lien.
The simplest way to do this is to make the contract subject to the existing
mortgage.
The contract is written for the full purchase price, but the buyer’s property
rights under the contract are subject to the rights of the seller’s
mortgagee.
The seller remains liable to make the payments on the loan and the
property may be foreclosed if the seller defaults.
The obvious problem with this arrangement, from the buyer’s point of
view, is how to make sure the seller does not default on the loan
payments.
The solution is to include in the contract a provision requiring the seller to
make timely payments on his or her loan and allowing the buyer to make
such payments directly to the lender if the seller fails to do so. TQ TQ
1. Contract Escrow
 In a CONTRACT ESCROW, the buyer makes payments into
the escrow account, and the escrow agent pays the seller’s
loan payments out of the account. The balance in the
account (after the loan payments are made) is disbursed to
the seller. In this fashion, the buyer is protected from the
consequences of a default by the seller. GOOD LUCK
FINDING THE ESCROW CO. TO DO THIS ….TQ
2. Estoppel Letter
 It is always good practice, in any transaction where an existing
mortgage is to be left in place, to obtain the lender’s written
consent to the proposed transaction.
 This is not essential where there is no alienation clause in the
seller’s promissory note or mortgage.
 The lender’s consent is given in the form of a letter, called an
ESTOPPEL LETTER, acknowledging the transfer and waiving
the lender’s right to accelerate the loan on account of the
transfer.
 By writing the letter, the lender is ESTOPPED (legally
prevented) from later trying to accelerate the loan on the basis
of the sale. UNLESS THEIR FORMS/PAPERWORK PROHIBIT
THIS!!! TQ
B. CONTRACT WITH ASSUMPTION
OF EXISTING MORTGAGE
 If the seller does not wish to remain liable for the
mortgage payments, but the buyer cannot (or will
not) refinance the debt, the buyer may be able to
assume (take over) the seller’s mortgage and pay the
balance of the purchase price under a contract.
 In this arrangement, the buyer becomes personally
liable for payment of the mortgage debt; the buyer
makes one payment to the mortgagee and another
payment to the seller.
C. CONTRACT PLUS ASSUMPTION
PLUS INSTITUTIONAL SECOND
 In some transactions, the seller will be willing to let
the buyer assume the existing mortgage and also be
willing to finance part of the price on a land contract,
but he or she will desire at least a partial cash-out of
his or her equity, perhaps to use as a down payment
on another purchase.
 If the buyer cannot come up with the cash from his or
her own assets, there is still an alternative: an
institutional second mortgage.
1. Lien Priority
2. Deeds and Security
III. Other Forms of
Creative Financing
A. LEASE/OPTION
 The lease/option plan is comprised of two
elements: a lease, and an option to purchase the
leased property within a specific time period
(usually within the term of the lease).
 An OPTION is an agreement to keep open, for a
predetermined period of time, an offer to purchase
or sell property. TQ
– OPTIONEE
– OPTIONOR
1. Consideration for an Option
 To be enforceable, an option must be supported by
consideration.
 The CONSIDERATION ($$ USUALLY $$) is something
of value given by the optionee to the optionor in return for
a commitment to sell the property to the optionee at some
time in the future.
 The consideration is usually a sum of money, but it can be
anything of value.
 It is sometimes called the OPTION MONEY.
2. Other Option Essentials
 An option is required to include all of the terms of the
underlying contract of sale.
 This means that a binding contract is formed at the
moment the optionee exercises his or her option to
purchase.
 Required information includes, but is not necessarily
limited to, the following:
1. names and addresses of the optionor and the optionee;
2. date of the option;
3. nature and amount of consideration;
4. words indicating that an option is being given;
5. date option expires; and
6. purchase price and essential terms.
3. How Does a Lease/Option Work?
 The seller/landlord leases the property to the
buyer/tenant for a specific term (six months, one
year, etc.), with the provision that part of the rental
payments may be applied to the purchase price if the
tenant decides to buy before the lease expires.
 The essential terms of a lease/option, in
addition to the option requirements recited
previously, include:
1.
2.
3.
4.
rental amount;
rent credit, if any;
reference to security deposit, if any;
a statement that a default by the optionee/lessee in
connection with the lease agreement will result in a
forfeiture of option rights; and
5. type of acceptable financing.
4. Advantages and Disadvantages of
the Lease/Option
 The main advantage of the lease/option is
keeping a sale alive until the parties are in a
position to close. TQ
 The primary disadvantage of the
lease/option is that the “seller” cannot
sell the property to anyone other than
the tenant during the term of the
option. TQ
5. Ways to Structure a
Lease/Option
 Crediting rental payments may be done in a
variety of ways, depending on the needs of
the buyer
 -(What the future lender looks for!!)TQ
 Rental payments may be credited towards the
amount needed for a down payment if the
buyer is short on cash (DOCUMENTATION)
 Payments can be used to reduce the amount
of financing required (only the amount that is
over what the current “normal” rent would
be.TQ
B. LEASE CONTRACT SEPARATE
FROM OPTION CONTRACT
 A problem with the lease/option agreement is that
too often the optionee/tenant does not exercise the
right to purchase.
 The result is wasted effort, with no sale and no
commission.
 A more forceful, and consistently more successful,
method of structuring lease/option arrangements is
to treat the lease and the option as two separate
contracts.
 TRIPLE-NET LEASE - in addition to rent, buyer is
responsible for payment of property taxes, insurance
and utilities.
C. LEASE/PURCHASE OR
LEASE/SALE
 A lease/purchase or lease/sale is quite similar to a
lease/option.
 The primary difference is that, along with a lease, the
buyer and seller sign a purchase and sale agreement
instead of an option.
 Most agents believe that a lease/purchase
arrangement is more likely to result in a successful
sale than a lease/option.
 As with a lease/option, the most reliable indicator of
a successful lease/purchase is usually the amount of
money put up by the buyer. $$ TQ
D. EQUITY EXCHANGES
 When a buyer cannot come up with sufficient cash
for a sale, the difference can be made up with
other assets, such as land, another house, cars,
boats, or any other property in which the buyer has
an equity interest and that the seller would be willing
to accept as part of the down payment.
 If the transaction involves an exchange of real estate
that is used in a trade or business, or is held for the
production of income or investment, some or all of
the capital gain can be deferred in a “tax-free”
exchange.
E. PARTICIPATION LOAN
 In a PARTICIPATION LOAN or shared equity loan, the buyer
enters into a form of partnership with an investor who provides
cash for the sale.
 The investor may be the seller, a bank, or any private investor.
 Instead of charging interest, the investor in a participation plan
receives a percentage of the EQUITY (the difference between
the property’s value and the indebtedness secured by the
property).
 Participation loans can be fairly complex in comparison to other
creative financing methods.
 Agreements such as these should be clearly spelled out, with
provisions for all possible contingencies.
 The services of an experienced real estate attorney should
always be obtained when preparing participation plan financing.
IV. Broker’s Responsibilities
Biggest one is don’t get sued! TQ
Keep everything on the up and up! TQ
Be honest! TQ
Tell the Truth, even if you’re going to lose
money. TQ
Just do it right, get help, use an attorney and
be sure everything is signed and notarized
and the deposit money is verified! TQ
Broker’s Responsibilities
 The old saying “where there’s a will, there’s a way” is
particularly true of creative finance.
 The advantages of open-minded negotiation among
buyer, seller, lender, and agent cannot be
overemphasized.
 However, when using an arrangement that has not
been tried and proven by others in the past, the
greatest care should be taken by the broker to
protect the rights of all parties through detailed
specification of all terms of the agreement, preferably
with the advice and assistance of legal counsel.
V. CHAPTER SUMMARY
 Seller financing provides an almost limitless variety of creative
alternatives to institutional financing and is particularly attractive in
tight money markets when loans from institutional lenders often
have prohibitive interest rates.
 Seller financing is also attractive to borrowers who cannot qualify for
an institutional loan.
 However, for seller financing to be a feasible alternative, the seller
must not have an immediate need for cash from the sale.
 Most seller-financed sales are of properties that are encumbered by
previous financing.
Chapter Summary (cont.)
 There are various ways to structure such a transaction,
and they include:










Assumption
Wrap-around Financing
Land Contract Subject to Existing Financing
Contract with Assumption of Existing Mortgage
Contract Plus Assumption Plus Institutional Second Mortgage
Lease Option
Lease Contract Separate from Option Contract
Lease/Purchase
Equity Exchange
Participation Plan
 Finally, professional brokers and agents who are involved
in creative financing need to exercise caution, enlisting
the services of a qualified real estate attorney. TQ TQ
Final Tip of the Night!
 Sometimes, if you
have to, wear a tie….
Hmmmmmm…….what is the??
Essay Question:
Why I (you) would write up a
lease option/land contract in
today’s market? (1 PAGE, 5
paragraphs!)