Today’s market environment has made it extremely difficult for sellers and buyers of real estate to consummate a transaction under normal procedures. Due to a severe drop in employment rate, tighter lending standards by mortgage companies, and the lingering effects of the recession on all aspects of the U.S. economy, sellers and buyers are resorting to alternative ways for a buyer to get into a house they can’t qualify for, or conversely, a seller to get out of a mortgage they can no longer afford.
To be sure, there is still an active need for residential real estate transfers. Despite the glut of new housing and foreclosed homes on the market, buyers whose credit or job status may have been adversely affected by the economic downturn are actively seeking out acceptable and affordable housing solutions for their families. Without bank financing, which is simply not available for those with marginal credit histories, affected buyers cannot qualify for houses making up the new home/foreclosed home market. Therefore, they are seeking out arrangements with owners of other properties who are needing a quick exit from monthly mortgage obligations due to their own economic losses, their inability to sell in a depressed market, or their need to move elsewhere in search of employment. The joinder of desperate sellers and buyers is resulting in the startling growth of alternative real state transactional structures which are full of peril for both parties and can often be used to fraudulently take advantage of unwary consumers.
For a number of reasons, sellers who need to sell are being forced to look to unqualified buyers to relieve them of their monthly mortgage obligations. Since these buyers are in need of housing but cannot obtain a new loan on their own, the joinder of the two seems to make sense. Unfortunately, the alternative structures agreed to by the parties in today’s environment are burdened by one inherent problem: in each of the structures, the seller’s existing mortgage is not paid off upon transfer of the property. Rather, buyers are taking over possession of a property which remains saddled with an unpaid pre-existing debt. The perils associated with this fact are grave indeed.
Typically, today’s alternative structures being utilized in distressed housing situations can be classified as one of three types of transactions.
The first structure, commonly known as a “contract for deed” or an “executory contract”, typically arises when a seller cannot get out from underneath a mortgage, and a buyer cannot obtain a new mortgage on their own. A contract for deed agreement provides that a seller will transfer possession of the home to a buyer in return for buyer’s promise to pay an agreed sales price at a stipulated sum every month. Until the sales price is paid in full, the seller retains the title to the property and can evict the buyer upon default at any time. Only at such time as the sales price is fully paid, often years later, will seller be obligated to give the buyer a deed, actually transferring legal ownership. Under this scenario, the seller is able to collect monthly payments from the buyer and apply them to his or her monthly mortgage obligations, and a buyer is able to begin making payments on a home without qualifying for a bank loan. Since a true closing does not occur at the outset, the cost and expense of documenting the arrangement are minimal. And since the seller has not conveyed title, he or she is protected from the credit-challenged buyer’s possible default.
But therein lies a huge problem for the buyer. Under this arrangement, a buyer must make monthly payments to the seller for property that is not in buyer’s name. The buyer must hope and trust that the seller will continue to apply the payments to the existing mortgage on a home in which he no longer resides. If seller fails to maintain such payments, all of the buyer’s payments and right to possession will be wiped out by a foreclosure of the existing loan, even if the buyer has paid current. The buyer must also hope and trust that when the entire sales price is paid, the seller will actually execute a deed transferring title to the buyer. If the original seller has passed away, the buyer could be in for some major challenges from the heirs of seller, who will question the entire arrangement and the amount of payments received.
In addition, by their very nature, such a transaction would violate the terms of the existing mortgage’s due-on-sale clause, giving rise to the lender’s immediate right to foreclose and take the property back.
From a seller’s prospective, the situation is not rosy either. While holding title, seller still retains liability for taxes, insurance and many accidents and damage which may occur on the property. Perhaps more alarming is that in placing the seller’s creditworthiness, not to mention seller’s largest financial asset (the home) into the care of a credit-challenged buyer, the seller is voluntarily placing his or her financial future at risk. Many times buyers with no equity in the game are much less inclined to make timely payments or maintain the property in good condition. Seller may have to take back a property ripped to the studs by an angry defaulting buyer. And to top it all off, the legislature has burdened such transactions of more than 3 year duration with extremely rigid rules which are cumbersome to comply with and subject to severe fines for failing to comply. Contracts for Deed are rarely a good idea for either side.
The second structure often utilized in distressed situations is referred to as a “Lease Purchase Contract”, whereby a buyer will lease a property from the seller and make monthly payments to the seller until buyer can qualify for their own mortgage. Typically, buyers are expecting that their monthly payment will be credited to the purchase price. However, the Texas Legislature considers such arrangements to be in essence the same as contracts for deed, with the same cumbersome rules, regulations and exorbitant fines for failing to comply. A buyer under a lease purchase arrangement also runs the same risk as that of a contract for deed buyer, where monthly payments are being paid with no ownership evidence filed of record and with only the hope that seller keeps the existing mortgage current. And complications arising from third party payments, tax implications, insurance coverage, tax and insurance escrows, etc. can easily doom a transaction. Despite their recent popularity, a desperate seller or buyer should be extremely wary of the dangers lurking beneath the surface of a lease purchase agreement.
The last structure of distressed real estate transactions is in many ways the preferred alternative, although not without its own risks. The seller can agree to go ahead and deed the property to the buyer at closing, so that title (and ownership liabilities) transfer immediately to the buyer. In this way, the buyer has documented ownership of the property which cannot be disputed by future heirs. At closing, the buyer signs a promissory note in favor of seller, promising to repay the sales price in full over a specified time period. Lastly, buyer signs a deed of trust mortgage in favor of seller, allowing seller to foreclose and take back title to the property if buyer defaults. So from a title perspective, this immediate transfer of ownership is a benefit.
However, the structure is still burdened by the fact that seller’s existing loan has not been repaid; a buyer who is current can still be wiped out by foreclosure if a seller doesn’t continue to pay the mortgage company, the transaction violates the seller’s mortgage, and insurance policies and tax/insurance escrows can be adversely affected.
Also under this scenario, a seller can retake possession of the home only through foreclosure, with the inherent risks and delays caused by bankruptcies, evictions and the lack of care and concern for the property by judgment–proof buyers.
The best solution? Find a buyer who can qualify for their own loan, and pay off the existing mortgage at closing. Short of that, however, sellers and buyers in difficult present situations should be extremely cautious in entering into any of the above real estate structures.
Copyright 2009 Jeffrey A. Rattikin, all rights reserved