Investing Strategy & Tips
Seven Ways To Reduce The Down Payment
By
Oct 13, 2005, 10:55

The most common obstacle to buying or selling property is that thee buyer can't afford to put up enough cash for the down payment the seller feels he must have.

However, there are plenty of ways to solve this problem. As we've already seen, a seller often changes his mind when offered more attractive long-term inducements such as collecting a higher interest rate, receiving bigger monthly payments and/or a bigger total price.

Using your broker's credit is a magically simple solution, if you have a smart broker with good credit or good connections. He can often call up the savings and loan, or some other lending institution, and get a loan that you couldn't otherwise get. (We're assuming now that you're the would-be buyer who can't come up with enough cash for the down payment). Sometimes he just knows the right person to talk to, and can persuade that person to grant you the loan. At other times he may be willing to put his own credit on the line by cosigning your note, so that if you default for any reason the lender can still collect from the broker. Also, brokers have been known to advance their own cash as payment for improvements to a property, if this is needed before the deal will make sense. 

A seller may pay a buyer's closing costs in order to swing a sale, if he's anxious to sell. Let's suppose that you're the seller now, dickering with a prospective buyer who has only enough cash for a down payment but can depend on plenty of income to meet the monthly payment requirements. If  you want to enable him to buy your house, one way of doing so is to pay his share of the closing costs as well as your own.

Normally, a buyer and seller both pay part of these costs. Customs vary from one area to another, but in most situations an escrow can be set up[ so that a seller pays most not all the closing costs and even the taxes, insurance, and impounds. If you as seller are willing, it still depends on the lender and the nature of the primary financing. New VA loans fit well into this situation. In VA financing, the seller must pay both the discount points and the buyer's escrow fee; all other costs and fees may be paid by either party. Thus your prospect, if he is eligible for a VA loan, conceivably could buy your house for absolutely no out-of-pocket costs, if you're willing.

Naturally you won't want to pay these extra costs, in most cases. But if this will ensure a quick sale, you may find it worth-while.

If the buyer is getting FHA financing, this plan won't work. FHA doesn't mid if the seller pays all the loan costs, but the seller gains nothing because under FHA financing the amount of the loan to the buyer is reduced by one dollar for every dollar paid by the seller in the name of the buyer.

The plan may or may not work in conventional loans, depending on the lender. Many banks and savings and loan firms won't allow a seller to pay part of a buyer's closing costs. Even so, you can get substantially the same results by adjusting the terms of purchase money or secondary financing or by other techniques.

Two VA loans to the same veteran are perfectly possible. Few people know this. May veterans who bought homes under VA guarantees some years ago are now buying other homes on stiffer financing terms because they think they've used up their GI eligibility, when they really haven't. They may be eligible for still more VA-backed money.

During World War II, VA loans guaranteed the lenders against loss up to $4,000. In 1951 this guarantee was upped to $7,500. In 1968 it was upped again to $12,500. In January 1975 the guarantee was increased still further to $17,500, and in 1978 it was raised to $25,000. VA loans can run up to $240,000 today. 

So if you're a veteran - or if you want to sell your property to a veteran - be sure to look into this. All veterans who took out a GI loan before 1978 have remaining guarantee entitlement of at least $7,500 and may be much more.

Remember, neither the Veterans Administration nor the law sets a maximum on the size of the loan the veteran can take out with any given amount of guarantee. This is up to the lender. However, if a vet meets the basic credit qualifications, he can generally feel sure of being able to buy a home with no down payment if it is appraised and priced at as much as four times the amount of his remaining guarantee entitlement. This means that someone with the full $25,000 entitlement can probably purchase a $100,000 home with no down payment except closing costs if he qualifies for the loan.

The delayed close is an arrangement that can help a buyer when the money market is so tight that he can't get a mortgage loan. Many deals fell through in 1965, 1974, 1980, and certain other years for the sole reason that lenders had no funds available. If anyone involved had known about delayed-closing arrangements, many of these transactions could have gone through. 

Imagine a situation where you and the other party have agreed on a sale price and down payment. All that is needed is a new modest-sized first mortgage loan. Often, in such situations, a bank or savings and loan knows it will have money available to lend again a few weeks or months later. If so, you needn't wait to sign the papers. Set up an escrow with a delayed close.

Under delayed-close escrows, the buyer can usually take possession of the property under an "interim occupancy agreement" at about the same time the seller receives the down payment. The buyer pays monthly occupancy fees to the seller. The seller keeps on making the payments on any existing loans. Then when the escrow finally closes, the buyer stops paying occupancy fees to the seller, and switches over to making whatever monthly payments the new lender is to receive under the terms of the mortgage loan.

Using a second mortgage as a guarantee can be another way of getting around the down-payment obstacle, in cases where a seller doesn't necessarily need a lot of cash but feels uneasy about a second mortgage that the prospective buyer offers in lieu of a down payment.

For example, imagine that you own a $125,000 commercial building, are ready to sell it, and are negotiating with a prospective buyer, Mr. Nemo. He offers you a $25,000 second trust deed he owns. "This will be my down payment", he proposes, "It will bring you $250 a month in payments from the borrower."

But you say, "What if that borrower defaults? Whoever holds the first mortgage on the property will get his money first. And I don't think the property will bring enough at a foreclosure sale to leave any money left over for me. If that could happen, then in effect I would have sold you my building for $25,00 less than I'm asking."

Nemo says, "Well, will you sell it to me for nothing down? I'm wiling to pay more per month if you will, and maybe shorten the term for paying off the whole amount."

You think this over. You don't know much about Nemo. If he gets in a bind, he'd have little to lose by making a payment or two and then waling away from your building. So you finally tell him, "No, I'm sorry, Mr. Nemo, but I just wouldn't feel safe with a nothing-down sale, and I wouldn't feel safe with your second mortgage either."

So is the deal off? Not at all, if you or Nemo or the broker do a little creative financial thinking. Here's what negotiators might work out - and actually did, in a recent transaction I happen to know about:

Nemo finally said, "Okay, I'll give you security against my defaulting on my contract to pay you $125,000 over the agreed-on term of years. I'll put up this $25,000 second trust deed as collateral. If I default, I'll lost the trust deed and it will be yours. Then will you feel safe with a no-cash-down sale?"

This arrangement is good for Nemo. He continues to collect $250 a month in payment son the second mortgage. The rents he collects as new owner of the $125,000 commercial building are enough to meet the monthly payments on it. And the seller has enough extra security so that the deal is worthwhile for him too. Of course there's still some possibility that both Nemo and the man who's paying on the second mortgage might default, but such a double disaster is unlikely. Even if it occurred, the $125,000 apartment house would revert to the earlier owner. So if you were the seller in such a situation, the deal with Nemo would be not only profitable but reasonably safe.

A performance second or third mortgage is one way that a buyer can safeguard himself when a seller demands more money than the property seems to be worth.

The phrase "performance mortgage" means a mortgage agreement that hinges on the rental income brought in by the property. 

When you propose a performance mortgage to an owner who seems to be asking too much, you make him put up or shut up. He says the property will generate enough income to justify the price he asks. If it really is worth this much, he has nothing to lose by signing a performance agreement. If he won't sign, he tacitly admits that he isn't so sure after all that his property will bring in as much income as he predicts. All you're doing is asking him to share some of the risk you'd take in accepting his estimate.

Performance-money mortgages are often used when a buyer takes over a property house with many vacancies. The seller says, "I'm sure you'll have no trouble getting enough tenants to fill up the building." Then the buyer may say, "All right, let's agree that you'll give me one dollar's worth of credit toward payments on the performance mortgage for every two dollars' worth of scheduled rent I don't receive because of vacancies. Then you won't be taking all the risk, and neither will I. On a one-for-two scale, I'll still have a strong incentive to try to fill up the building. But I won't lose my shirt if this is impossible, because you'll forgive part of my mortgage debt to you." A seller who is sincere can scarcely refuse such a proposition.

A profit-sharing agreement is for persuading a seller to accept a smaller down payment than he is asking.

Incidentally, please don't jump to the conclusion that this exhausts the list of possibilities. There are many, many other possible ways of structuring a purchase through creative financing. In fact, I've counted 173 such ways.

This tactic can often enable you to buy income property with absolutely nothing down. The private investor puts up the full down payment in return for a stipulated interest rate plus a share in the profits, or the cash flow, or the gross rental income. Do you see what tremendous leverage you get when you buy a property this way? You're acquiring a money maker without putting any cash on the line. Therefore, you can well afford to offer a lender a much bigger share of the prospective benefits of ownership than he is likely to expect or demand. It's a great deal for both of you.

In effect, he is becoming at least a minor partner in your enterprise.

Entering into profit-sharing agreements of some kind is now helping many young couples to buy their first home. They might otherwise be priced out of the market because of the high prices and big down payments sellers are demanding.

If you heart is set on a particular house and you find yourself in this position, look for an investor who'll be happy to put up the down payment for you in return for a share in the profits when you sell, or for a share in the rent receipts while you own the house. Almost any real estate broker will be able to steer you to such investors. Many of them prefer a steady income to a lump-sum capital gain.

In a typical situation, the investor might put up the entire down payment, and you would make the monthly payments as they fall due. You would also pay for the insurance, taxes, and maintenance. Then, when you sell, he'd get his money back plus stipulated minimum return on his money as well as a percentage of all additional profits you realize. There'd be an agreement that you'd either sell or otherwise settle with him for his interest by a certain date (perhaps five or seven years in the future). By that time the property would probably be worth considerably more than you paid for it, so that you could refinance it and pay the investor off (thereby making you the sold owner) if you wish. You and he would calculate the amount due him, using an appraiser's valuation at that time. 

Such an arrangement can also be helpful in meeting the monthly mortgage payments. If the investor puts up all the money for the down payment, you'll still have whatever money you had saved up for the purpose, and can draw on it if the monthly payments become too burdensome.

There can also be situations where you have enough money to make the down payment but insufficient income to qualify for the mortgage. An investor might help here by agreeing to assume part of the monthly payments in return for some similar sharing of the profits when you sell.