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Archive for the ‘Hard Money Financing’ Category

The subject of this article is very important to the investor who wants his rehabs or flips to have the largest possible pool of potential buyers. While I do invest in houses of all price ranges, I have found it easier and faster to sell homes that fall within the FHA lending limits.

FHA loans are designed (and guaranteed by our government) to encourage home ownership for buyers with limited financial resources and often imperfect credit. There are several programs floating around that will actually let you get into a house with an FHA loan for nothing down. Again, I want to make the point that nothing down is easy in the present day and age, finding the deals is the hard part. Your mortgage broker would know about these, as they are national in scope. The credit score is not nearly as important with FHA (or VA) homes as with conventional loans. In general, the underwriting requirements are easier than on a conventional conforming loan, and the closing costs are extremely low. Borrowers can qualify with minimal cash reserves.

The drawback of FHA loans is that the homes sold must meet FHA standards, which means that the appraiser does not want to see any deferred maintenance due on the property. If you are selling a beaten up house, you should be careful before accepting an offer in which the buyer plans to obtain FHA financing. You may have to make some repairs, at your cost, to get the house up to the appraiser’s standards. In the next article (The Average Appraisal and the “Flip”), I discuss the requirement in most owner-occupant loans that the property be in “average” condition. The FHA requirements are generally stricter than this requirement as a rule of thumb.

“I heard that FHA loans are terrible from the Seller’s Perspective . . .”

There are opinions about FHA financing that range from good to bad from the seller’s perspective. Many of the bad opinions concerning FHA loans arose under the old way that these loans were set up. Under that system, there were requirements for the types of finishes that would be inside the house. You have probably heard the expression “FHA grade carpet or vinyl.” FHA required that the carpet be of a certain pile if they were going to do the loan.

In lieu of hypotheticals, I can give you some real examples of deals done with FHA lending. An investor who works in some of the same neighborhoods that I do recently sold a house to a buyer who obtained an FHA loan. The FHA guidelines as quoted by the appraiser required my investor friend to erect hand rails off the back steps, put in gravel for a driveway, put screens on all the windows, and fix numerous other small items. My most recent FHA sale had no requirements (it was on a total rehab), the one prior to that required splash blocks under the gutter downspouts. Another house I sold FHA required that a screen door be fixed. Not a big deal. These are really aggravation items, but nothing that could break a deal.

Side-Note: VA Loans generally require the house to be in excellent shape. When our family business was building new homes, many of these were sold VA in some sub-divisions that we developed. VA put numerous requirements on the properties before they could be conveyed, and made demands that really verged on cosmetics. Recently, my wife’s family sold a home, and the seller sought financing through a VA lender. The only requirements they were given were to clean ants off the electric meter and turn up the hot water temperature. Strange, but no big deal . . .

If you are selling homes that are in generally good and clean condition, you have nothing to worry about.

How This Relates to Choosing Your Target Neighborhood

FHA loans are important to think about when you are beginning your real estate investing career. When we select a neighborhood to invest in, one thing for us to consider is whether or not we could rehab the property and sell it via an FHA loan. FHA has a maximum amount that they will lend in each given area, or county. This amount is moved up or potentially down to reflect the actual cost in an area for acquiring a fairly nice property. Thus, in my county, which is metro-Atlanta, we have a much higher limit than in a more rural county with lower housing values.

Many people just cannot qualify to buy without FHA, and if we shut them out with a higher priced property, it may take a little longer to sell our home. If you are selling your home within the FHA limits, you also know that you are right in the thick of the market.

Thus, if you are trying to decide on two different areas to invest, and all else is equal, go with the area where you can market your properties within the FHA financing price limits. Another advantage generally on dealing with this type of buyer is that they often are younger buyers who do not intend to stay in the house forever. You can thus market smaller properties to them (though I prefer 3 bedroom homes!), and properties that are neat and clean but not trimmed out expensively inside. They are probably coming from an apartment, so the house will seem nicer than where they have been.

A home equity line of credit (“HELOC”) can be an excellent financing tool, if it is used properly. A HELOC is basically a credit card secured by a mortgage or deed of trust on your property. You only pay interest on the amounts you borrow on the HELOC. If you don’t use the line of credit, you don’t have any monthly payments to make. You can access the HELOC by writing checks provided by the lender. In most cases, it will be a second lien on your property.

HELOCs are being advertised on television as a way to consolidate debt, but can be used much more effectively by investors. When you need cash in a hurry for a short period of time, a HELOC can be very useful. For example, if a seller tells you, “give me $75,000 cash on Friday and I’ll sell you my house for a song,” you need to act in a hurry. Another example of cash in a hurry is a foreclosure auction, which, in many states, requires payment at the end of the day of the auction. When you need cash in a hurry, there’s no time to go to the bank.

While the HELOC may be a high interest rate loan, it is a temporary financing source, which can be repaid when you refinance the property. Do not use your HELOC as a down payment or any other long-term financing source – it will generally get you into financial trouble. If you don’t pay the HELOC, you can lose your home!
Some institutional lenders will not lend you the balance if you borrowed the funds for the down payment. However, smaller commercial banks that “portfolio” loans have more flexibility and may allow you to use HELOC money as a down payment. Once again, I must caution you about using borrowed money in this manner – only do it if the deal is a steal and you can pay off the HELOC money within a few months.

Deducting HELOC Interest

There are limits on the deductions you can take on your personal tax return for interest paid on your HELOC. Generally speaking, you can only deduct that portion of interest on debt that does not exceed the value of your home and is less than $100,000. But, if you do your real estate investments as a corporate entity, you can always loan the money to that entity and have the entity take the deduction as a business interest expense. This transaction must, of course, be reported on your personal return, and must be an “arms-length” transaction (i.e., documented in writing and within the realm of a normal business transaction). Consult with your tax advisor before proceeding with this strategy.

Using Credit Cards

You may already have more available credit than you realize. Credit cards and other existing revolving debt accounts can be quite useful in real estate investing. Most major credit cards allow you to take cash advances or write checks to borrow on the account. The transaction fees and interest rates are fairly high, but you can access this money on 24 hours notice. Also, since credit card loans are unsecured, there are no other loan costs normally associated with a real estate transaction, such as title insurance, appraisals, pest inspections, surveys, etc.

Often, you will be better off paying 18% interest or more on a credit line for three to six months than paying 9% interest on institutional loans, which have up front costs that would take you years to recoup. Again, use credit cards carefully and only as a temporary solution if the deal calls for it.

The mortgage business is a complicated and ever-changing industry. It is important that you understand how the mortgage market works and how the lenders make their profit. In doing so, you will gain an appreciation of loan programs and why certain loans are offered by certain lenders.

Institutional Lenders

The first broad category of distinction is institutional versus private. Institutional lenders include commercial banks, savings and loans, credit unions, mortgage banking companies, pension funds, and insurance companies. These lenders generally make loans based on the income and credit of the borrower, and they generally follow standard lending guidelines. Private lenders are individuals or small companies that do not have insured depositors and are generally not regulated by the federal government.

Primary Versus Seondary Market

First, these markets should not be confused with first and second mortgages. Primary mortgage lenders deal directly with the public. They “originate” loans, that is, they lend money directly to the borrower. Often referred to as the “retail” side of the business, lenders make a profit from loan processing fees, not the interest paid on the loan.

Primary mortgage lenders generally lend money to consumers, then sell the mortgage notes (in large packages, not one at a time) to investors on the secondary mortgage market to replenish their cash reserves.

The largest buyers on the secondary market are the Federal National Mortgage Association (FNMA or “Fannie Mae”), the Government National Mortgage Association (GNMA or “Ginnie Mae”) and the Federal Home Loan Mortgage Corporation (FHLMC or “Freddie Mac”). Private financial institutions such as banks, life insurance companies, private investors, and thrift associations also buy notes.

Mortgage Brokers Versus Mortgage Bankers

Many consumers assume that “mortgage companies” are banks that lend their own money. In fact, a company that you deal with may be either a mortgage banker or a mortgage broker.

A mortgage banker is a direct lender; it lends you its own money, although it often sells the loan to the secondary market. Mortgage bankers (also known as “direct lenders”) sometimes retain servicing rights as well.

A mortgage broker is a middleman; he does the loan shopping and analysis for the borrower and puts the lender and borrower together. Many of the lenders through which the broker finds loans do not deal directly with the public (hence the expression, “wholesale lender”).

Conventional Versus Non-Conventional

“Conventional” financing, by definition, is not insured or guaranteed by the federal government. Conventional loans are generally broken into two categories: “conforming” and “non-conforming.” A conforming loan is one that conforms or adheres to strict Fannie Mae/Freddie Mac loan underwriting guidelines.

Conforming loans are a low risk to the lender, so they offer the lowest interest rates. Conforming loans also have the strictest underwriting guidelines.

Conforming loans have three basic requirements:

* Borrower Must Have a Minimum of Debt: Lenders look at the ratio of your monthly debt to income. Your regular monthly expenses (including mortgage payments, property taxes, insurance) should total no more than 25 to 28% of gross monthly income (called “front end ratio”). Furthermore, your monthly expenses, plus other long-term debt payments (e.g., student loan, automobile, alimony, child support) should total no more than 36% of your gross monthly income (called “back end ratio”). These ratios can sometimes be increased if the borrower has excellent credit or puts more money down.

* Good Credit Rating: You must be current on payments. Lenders will also require a certain minimum credit score called a “FICO” (http://www.myfico.com).

* Funds to Close: You must have the requisite down payment (generally 20% of the purchase price, although lenders often bend this rule), proof of where it came from, and a few months of cash reserves in the bank.

Non-Conforming Loans

Non-conforming loans have no set guidelines and vary widely from lender to lender. In fact, lenders often change their own non-conforming guidelines from month to month.

Non-conforming loans are also known as “sub-prime” loans, because the target customer (borrower) has credit and/or income verification that is less-than-perfect. The sub-prime loans are often rated according to the creditworthiness of the borrower – “A,” “B”, “C” and “D.”

The sub-prime loan business has grown enormously over the past ten years, particularly in the refinance business and with investor loans. Every lender has its own criteria for sub-prime loans, so it is impossible to list every loan program available on the market. Suffice it to say, the guidelines for sub-prime loans are much more lax than they are for conforming loans.

When considering an investment property loan from an institutional lender, you need to consider many of the variables involved in the loan terms being offered.

Interest Rate

The cost of borrowing money, i.e., the interest rate, is one of the most important factors. Interest rates affect monthly payments, which in turn affects how much you can afford to pay for a property. It may also affect cash flow, which affects your decision to hold or sell property.

Loan Amortization

There are many different ways a loan can be structured as far as Simple interest and Amortized. A simple interest loan is calculated by multiplying the loan balance by the interest rate. So, for example, a $100,000 loan at 12% interest would be $1,000.00 per month. The payments here, of course, represent interest-only, so the principal amount of the loan does not change.

An amortized loan is slightly more involved. The actual mathematical formula is complex, so it requires a calculator (try mine, at www.legalwiz.com – click on “calculators” from the left navigation bar). The amortization method breaks down payments over a number of years, with the payment remaining constant each month. However, the interest is calculated on the remaining balance, so the amount of each monthly payment that accounts for principal and interest changes. For the most part, the more payments you make, the more you decrease the amount of principal (the amount of the loan still left to pay) owed.

Balloon Mortgage

A balloon is a premature end to a loan’s life. For example, a loan could call for interest-only payments for three years, then be due in full at the end of three years. Or, a loan could be amortized over 30 years, with the principal balance remaining due in five years. When the loan balloon payment becomes due, the borrower must pay the full amount or face foreclosure

With interest rates uncertain in the future, many lenders are offering variable-rate financing. Known as an “ARM” loan (adjustable rate mortgage), there are dozens of variations to suit the lender’s profit motives and borrower’s needs. ARM loans have two limits (“caps”) on the rate increase. One cap regulates the limit on interest rate increases over the life of the loan; the other limits the amount the interest rate can be increased at a time. For example, if the initial rate is 6%, it may have a lifetime cap of 11% and a one-time cap of 2%. The adjustments are made monthly, every six months, once a year or every few years, depending upon the “index” the ARM loan is based. An index is an outside source that can be determined by formulas, such as:

* “LIBOR” (London Interbank Offered Rate) – based on the interest rate at which international banks lend and borrow funds in the London Interbank market.

* “COFI” (Cost of Funds Index) – based on the 11th District’s Federal Home Loan Bank of San Francisco. These loans often adjust on a monthly basis, which can make bookkeeping a real headache!

* T-Bills Index – this is based on average rates the Federal government pays on U.S. treasury bills. Also known as the Treasury Constant Maturity or “TCM”, these are the rates banks are paying on six month CDs.

You’ve seen the emails:

“Legally eliminate your mortgage!”

Can this possibly be true? Well, I’ve read the claims and researched the law and here’s what I came up with.

The Claim

The claim is that you can legally eliminate your mortgage based on an accounting loophole that goes something like this…

“If the lender who funded your loan used borrowed money to fund your loan, then the loan is not valid. And, since the loan is not valid, the security (mortgage or deed of trust) is not valid either. All you do is simply march into court and ask a judge to void your mortgage lien, and you don’t have to pay it back.”

Now, without going into the legal issues, a common sense approach would tell you that the entire premise of this argument is patently absurd. Think about it… most lenders use borrowed money to fund loans, that’s the nature of the business.

So, if these “mortgage elimination” promoters are correct, then millions of mortgages would be void. The entire economy would collapse. This sounds vaguely familiar to the “tax protestor” scam where people claimed that they didn’t owe income tax because the government did not have the constitutional authority to tax them. More on that later…

The Law

The mortgage elimination promoters cite various court cases in support of their position. At first blush, it would seem there are dozens of court cases in which the judge actually did what they claimed, that is, declare a mortgage void because the lender used borrowed funds for the loan. But, since most laymen are not trained in the law, they take this stuff, hook, line and sinker.

I’ve read the decisions and they all have a common theme: they don’t support the mortgage elimination theory. In fact, most of the cases are only vaguely on point.

The “tax protestor” promoters did the same thing… take a quote from a judge’s decision out of context and cite the case as support for their position. In the end, the tax protestors all lost in court, paid large fines and went away with their tails between their legs. The government went after the promoters of the scam.

Similarly, the government is going after the promoters of the mortgage elimination scam. The Federal Reserve recently issued a warning, a copy of which can be found at the end of this article. The Office of the Comptroller of the Currency issued a similar warning last year.

The Minnesota Attorney General has also gone after a company that has allegedly charged consumers as much as $7,500 for this scheme.

The Cult of Stupidity

As I write this, undoubtedly a few “followers” of the theory will email me and argue that I don’t understand or that I’m part of the “establishment mentality” that keeps the little guy down. Of course, these are likely the same people who are collecting referral fees from the scammers that are charging thousands of dollars to consumers in exchange for a false promise to eliminate their mortgages.

On a philosophical level, I appreciate discussions about how the dollar really isn’t backed by gold, the government doesn’t have the right to tax Americans and the the like. But I wouldn’t tell a client to actually rely on any of these theories in a court of law. Nor would I charge someone thousands of dollars in exchange for a promise or guarantee that their mortgage could be eliminated without paying it off.

How to Really Eliminate Your Mortgage

There are some legal ways to eliminate your mortgage:

1. Pay it off in full.

2. File for chapter 7 bankruptcy (in which case you will not be liable for the mortgage note, but you will also lose the house).

3. Find a REAL legal challenge that a judge is willing to accept as a valid reason to declare the debt void, such as usury, gross violation of lending laws, fraud, incompetency or the like.

Q: I am a new investor (I bought my first rental 18 months ago and now have 5 houses) and I am having a “cash crunch” due to some vacancies and some rehabs I need to do. Is it smart for me to refinance some of my houses with interest-only loans to reduce my payments, then refinance again in a year or so to get the payoffs back on track?

I have major concerns about this plan, especially for you as a “new investor.” There’s nothing wrong with interest-only mortgages; in fact, I’ve gotten a few of these myself, when the numbers made sense and the lender was willing. The problem with refinancing and doing it twice, is the expense involved. A typical refinance with a mortgage broker (and I assume you plan to use a broker, since “traditional” lenders usually don’t tend to offer this kind of product) costs $2,000-$4,000 in closing costs, application fees, points to the broker, and so on. These costs are not recoverable by you in terms of a higher property value or increased rents, the way money spent upgrading the property would be. They are pure expense and lower the overall return on and profit from your deal.

What you are proposing is to refinance not once but twice in the upcoming year, meaning that you could be looking at up to $8,000 in additional expense for the privilege of making lower payments for awhile—maybe. When you begin to look at the rates charged by lenders for interest-only loans, you’ll find that they are sometimes higher than for loans that will eventually amortize themselves. I’ve recently seen rates on interest-only loans as high as 13%, which makes no sense for you if your goal is to have higher cash flow. If you do the math, you may find that the interest-only loans you’re being offered actually have higher payments than your existing, fully amortized loan!

But the thing that concerns me most about your question is that, in my experience, continually refinancing properties to pull cash out or to improve the terms of a loan is a big mistake. In fact, when I see investors go belly-up, it’s always because of one of 2 things: overspending on renovations or over-financing their properties to the point where there’s no equity (or cash flow) in the property. In fact, over-financing isn’t just a problem for beginners–it’s has been responsible for the downfall of many experienced investors, as well.

My suggestion? Either sell one or more of your non-performing properties, or—better yet—wholesale a few deals for a $4,000-$7,000 profit to meet your immediate cash needs. And in the future, try to keep some of those rents in reserve for occasions like this: they will occur again and again, and the best way to weather them is to be prepared for that fact.

Private mortgage loans are made by private lenders instead of traditional financing sources such as banks, lending institutions, or government agencies. They usually are short-term (6 months to 3 years) hard money or asset-based loans, and the decision to lend is based on the equity and value of the property being put up as collateral, not on the borrower’s credit.

These loans are a source of funding for professional real estate investors who wish to acquire, rehabilitate, or cash out equity of income producing property, and those who otherwise would not qualify for conventional financing. Private mortgages also assist real estate investors who need immediate financing without the financial documentation required by traditional institutional financiers.

Private mortgage loans are very secure because they represent a maximum of 65 percent to 70 percent of the appraised value of income producing property. On non-income producing property, a maximum of 55 percent loan to value is lent. Investors can expect to pay interest rates of 12 percent to 14 percent on first liens and 16 percent to 18 percent on second liens in this current low interest rate environment. Historically, first lien yield of six points over prime has been obtainable.

Why Borrow Private Money?

When interest rates of 14 percent to 18 percent are added to four to eight points, the borrower is paying more than 20 percent annually for a private mortgage loan. This is a good deal for private mortgage lenders, but why would borrowers want to pay these high rates when conventional mortgages range between 7 percent and 10 percent? Many reasons exist, but all fall into four categories.

Speed of Closing

Conventional mortgages usually take between 45 days and 90 days to fund, since institutional lenders need to obtain an appraisal of the property’s value, perform a detailed examination of the borrower’s credit history, and thoroughly evaluate the borrower’s current financial status. On the other hand, private mortgage lenders usually can complete a transaction within seven to 10 days. Since the property itself is the main criteria used to determine loan eligibility, less information on the borrower is required, resulting in a much quicker approval process.

The private mortgage lender is protected by lending at a significantly lower LTV ratio: 65 percent vs. 80 percent to 90 percent for institutional lenders. Further, the private mortgage lender can make a decision within 24 hours of receiving information, whereas institutional mortgage money must be approved by a loan committee that may meet only twice a month.

Easy Application Process

While a borrower’s lack of up-to-date personal financial information would negate or at least delay approval for an institutional mortgage, it should have no effect on the ability to obtain a private mortgage loan. Private mortgage lenders generally base their decisions on the asset used for collateral — the property. If the property value is high enough and the income being generated from it is sufficient to pay the interest on the debt, the borrower’s personal financial situation should not affect the private mortgage lender’s decision.

Other Money Resources Are Not Available

A borrower may not qualify for an institutional mortgage loan for reasons ranging from low borrower credit scores or too much borrower debt. Further, the property itself may not support the type of loan the borrower wants: Many institutional lenders will not loan amounts under $500,000 and will not lend second lien money even if there is significant equity in the property.

In these cases private mortgage lenders may be the only available resource. Institutional lenders are concerned with both the appraised value of the property and borrower and property credit; however, private mortgage lenders are concerned only with the appraised value, as long as it represents a fair market price. Hence, if a property is producing or can produce sufficient income to pay the note and the value of the property will provide sufficient equity, the borrower’s credit is not an issue for the private mortgage lender.

More Funds Available

Since private mortgage lenders base loans on the appraised value of the property, the borrower may be able to borrow more and therefore have less of its own capital invested in the property. In these instances, the borrower is not penalized for purchasing a property at a significant discount to market value.

Investment Parameters

The most important parameter private mortgage lenders consider when evaluating a loan request is LTV ratio. They typically will lend up to 50 percent on raw land or undeveloped property; 65 percent on commercial income producing property such as office buildings, shopping centers, and warehouses; and 70 percent on multifamily income property such as apartment complexes. The maximum amount usually will be lent if all criteria are met; lower amounts may be lent if the loan or borrower is considered less than ideal.

The second parameter is the type of properties to lend on, which often is determined by the ease in disposing of the property in case of default. Obviously, a single-use property that would take a year to sell is less desirable than a multi-tenant, income producing office building.

The third investment parameter is the cash flow or income potential of the property put up as collateral. Although many private mortgage lenders are liberal in this area, the monthly interest payments must come from somewhere. If the property is producing a cash flow after all expenses, the property income alone may cover the monthly payments without the borrower having to come out of pocket. This adds a great degree of safety to the note. Cash flow from other income properties also can substitute for cash flow from the property being placed as collateral.

The fourth major investment parameter the lender must consider is exit strategy, or how the borrower plans to repay the loan. Since most private mortgage loans are short-term, private mortgage lenders have a keen interest in analyzing whether a particular exit strategy is viable. For example, if the exit strategy is to refinance the property, the lender must determine if the credit score of the borrower is high enough to qualify for a long-term mortgage, if the property cash flow is sufficient to cover the debt payments, and if the property will meet the general criteria set up by the mortgage lenders most likely to refinance the property.

Pre-Qualification letters are not absolutely necessary, but if you want to pursue bank owned and HUD homes they are a necessity if you don’t have provable cash. A pre-qualification letter from a lender let’s the seller in your real estate transactions know that you have at least taken the time to speak with a lender, and that the lender has preliminarily agreed to lend you money in a future transaction.

You can get pre-qualification letters from a lender or someone who represents a lender such as a mortgage brokers. For some people lenders pre-qualification letters are something that they write regularly. For others they have a fear of writing them because they don’t understand what they are being asked to do.

Commitment letters are something that used to be issued all the time in the past. I don’t know of lenders who will write commitment letters anymore. They want to be able to back out of deals last minute, and commitment letters have been used against lenders in courts. When asking for a pre-qualification letter, be sure to stress that you just want a letter stating that you are pre-qualified for a loan, and that the pre-qualification is subject to further review and due diligence. This gives the lender an out, it is not a commitment letter.

The pre-qualification letter that I used for well over a hundred deals read as follows:

To Whom It May Concern:

This is to confirm that Steve Cook has been pre-qualified for a purchase/rehab loan for a single family residential property based on a 70% loan to value appraisal, but with no cash out. This pre-qualification is good for 60 days from the above date and is renewable by mutual written consent.

As always, final loan commitment is subject to the appraised valuation of the property by an appraiser chosen by our firm.

Thank you for your cooperation.

Sincerely,

Mr. Hard Money Lender

In recent years, the number of mortgage brokers vying to make loans in the small residential property market has exploded. With this increased competition has come some advantages for the real estate investor: increased availability of fixed rate loans, more willingness on the part of brokers and lenders to work with marginal credit, 10% down investment property loans, and other decided improvements in the ease of borrowing money. Lately, though, in an attempt to increase profits in the face of ever harsher competition, some mortgage brokers have crossed the line between “creative” and “illegal” – and you may be subject to fines and jail time as a result.

In order to understand the nature of the problem, it’s important to first understand the role of a mortgage broker in the lending process. A mortgage broker does not lend money. Instead, he works with several lenders who make mortgage loans, serving as a “go between” who finds, qualifies, and “sells” borrowers on a lender’s products. The broker gets paid a fee – from 1% to 10% of the loan amount – for putting the transaction together and guiding it to a successful closing. No closing, no paycheck for the broker. Because many borrowers don’t make the distinction between the mortgage broker and the lender, they are not at all alarmed when the broker suggests “doctoring” a deal in order to get 100% financing for the buyer. They assume that if the mortgage broker says it’s OK, the lender must be in on it. The truth is, the lender is usually in the dark.

Here’s the kicker: according to federal law, if you knowingly participate in one of these loan schemes by falsifying documents or signing a settlement statement that you know to be fraudulent, you could pay a fine of $1 million and spend the next 20 years at Club Fed. The loan schemes that you are most likely to run across as a real estate investor will take one of two general forms.

#1). Your lease/optionee wants to exercise his option to buy, but with his substandard credit, no lender will touch him with less than a 20% down payment. The mortgage broker suggests that you write up a land contract backdated at least one year, so that the loan can be treated as a refinance rather than a new purchase. The broker then gets an appraisal on the property for 20% more than the tenant/buyer’s purchase price, gets the bank to loan 80% of the appraisal, and viola’! 100% financing.

The problems here are twofold: you have provided and signed a fake land contract, possibly dated before the tenant/buyer even moved in. The mortgage broker has procured an appraisal for significantly more than the property is worth. Thus, the lender has made a loan to a high-risk borrower on a property that now has no equity on your word that the nonexistent land contract account was faithfully paid. It’s important to note that some mortgage brokers actually do work with lenders who will refinance 1-day old land contracts. If this is the case, you won’t be asked to falsify dates on your land contract. No fraud, no future problems for you.

#2). You want to buy the nice rental house up the street, but the owner wants $40,000 and you don’t have the 20% down payment the bank wants. The owner suggests that you write a contract with a $50,000 price, and an owner-held second mortgage for $10,000. The bank will loan you 80% of the purchase price, or $40,000. After the closing, the seller will tear up the second mortgage, leaving you with a total purchase price of $40,000. Viola’! 100% financing.

This little scam has been going on for decades, and in most cases, no one is ever caught or punished. However, the practice has become so widespread that, in some states, the departments of commerce have formed investigative committees to look into these fraudulent transactions. More and more stories about Realtors, mortgage brokers, investors, and home buyers facing stiff fines and jail time are appearing in the paper. And beware the next economic downturn: these loans will go bad, they’ll be investigated, and heads will roll. Think about this next time you’re tempted to sign a closing statement that doesn’t reflect what’s really happened. With all the ways to do deals creatively and legally, why put yourself at risk?