What are the Investors, Buyers, Sellers and others involved in the Real Estate Industry to do in these times where foreclosures and evictions are prominent and bank loans are very hard to find or come with such requirements that make it almost impossible to do business? Many Real Estate investors are finding themselves taking non-traditional paths in order to make deals happen. Due to buyer’s inability to obtain financing, many sellers are now turning to variations of “owner-financing.” Some sellers are offering options for buyers such as note/mortgage seller financing, wrap mortgages, land contracts, leases, and leases with options to purchase. Some of these non-traditional paths can be fraught with unexpected consequences and need to be examined carefully, with the risks fully understood before they are attempted.
The sellers who offer to sell their property and provide owner financing by taking back a note and mortgage are in essence becoming the bank. They trade their ownership in the property for a promissory note, a promise to pay, secured by a lien on the property. Before entertaining this type of transaction the parties need to understand the transaction and the consequences if the transaction goes bad. The state of the economy is the reason the parties are entering into the nontraditional transaction, but these same parties may find themselves joining the multitudes of banks and debtors in line at the court house, and a part of the foreclosure fiasco. The traditional banks have always been meticulous in documenting and securing their loans. A seller should be just as meticulous. Choosing the appropriate promissory note and/or the appropriate mortgage can save the seller months and even years of litigation expense. Assuming the parties finally get to the point of a sheriff sale, the parties need to know about the bidding process, deficiency judgments, and what a bankruptcy might do to the process.
If the seller does not own the property free and clear from any encumbrance, the owner financing becomes that much more problematic. The seller might try to sell the property subject to their mortgage. These sellers might use a wrap mortgage behind their lender’s mortgage in an attempt to secure their position in the event their buyer fails to pay the mortgage. An understanding of the bidding process in foreclosure is important to know the consequences of such a wrap mortgage especially since it is in the secondary position. However, the seller’s mortgage company, more often than not, placed a due on sale or due on encumbrance clause in its mortgage. These clauses allow the first lender to call the loan and foreclose upon the property if the property is conveyed or another lien is put on the property. The seller’s mortgage company could send both parties into the foreclosure process notwithstanding the faithful payment of the monthly installments on the first mortgage.
Some sellers and buyers have turned to the land installment contracts in order to sell and buy a property. These contracts are defined and governed by Chapter 5313 of the Ohio Revised Code. In general these contracts are executory agreements where the seller agrees to convey title and the buyer agrees to pay the purchase price in installment payments while the seller retains title to the property as security. These contracts became popular in the early 1980’s when mortgage interest rates soared into the mid teens. Buyers did not want to buy at those rates, and promised to pay seller’s mortgage which was at a much lower rate. Since the 1980s most banks became wise to this concept and now these contracts typically violate the due on sale clauses as described above. The current financing slow down has caused a resurgence of this contract. Aside from the foreclosure procedures described above, Chapter 5313 imposes certain obligations on the seller such as the recording of the contract, and provides for various remedies depending on the state of the economics of the contract at the time of default. Even though sellers retain title to the property, they may be required to foreclose upon default as opposed to evicting. Buyers do not have title to the property and therefore need to concern themselves as to whether the seller can convey title at the point of maturity of the contract.
Instead of selling, some investors are leasing their property. Leases with options to purchase are alternatives for owners to hold on to potential buyers for their properties until the buyers are able to finance the properties on their own. Drafting of the lease must be done carefully to avoid the transaction from falling within the laws and obligations governing land installment contracts. If the lease is for the use and occupancy of residential premises, the parties may be subjecting themselves to the Landlord/Tenant Laws. These laws impose specific obligations on the Landlord and Tenant, some of which may not have occurred to the parties since their ultimate intent was a sale and purchase of the property. As with the land installment contract, the seller should determine whether the lease terms violate the terms of their mortgage, and the buyer should concern themselves with whether this seller can transfer the property at the time they exercise the option to purchase.
While sellers and buyers are using alternative means to close deals, they must do so with careful consideration to the risks. Entering these transactions on a whim, without due consideration is a formula for disaster. That does not mean that the parties should not utilize alternative and creative means to get the deals done; indeed, that may be the only way to do business in these times. However, this is not the time to cut corners. Both sellers and buyers need to make sure that each business deal is done in a manner that reduces their risks, or at least that they understand those risks.