Creative Ways to Buy and Sell Real Estate in Texas
A typical real estate transaction, whether residential or commercial, usually involves a buyer paying a certain amount in cash for a down payment and taking on a new mortgage for the rest of the purchase price, cashing out the seller at closing. However, there are many situations when a typical transaction just won’t work. Maybe the buyer doesn’t have enough cash for a 20 percent down payment or can’t qualify for a conventional bank mortgage. Or maybe the seller is determined to get a certain number for the sales price or needs to sell the property very quickly.
In cases like these, the parties do have other options – creative ways to buy and sell real estate. In most of these creative transactions, the seller will transfer the title to the property to the buyer (the deed) without paying off the existing mortgage (the deed of trust). This is perfectly legal in Texas – as long as you comply with certain state and federal statutes designed to protect buyers from predatory lenders.
Let’s take a look at a few of the creative ways to buy and sell real estate in Texas.
If the seller’s existing mortgage has a favorable interest rate – preferably fixed – the buyer can purchase the property “subject to” that mortgage. The buyer pays the seller a cash down payment for the seller’s equity, but instead of getting a new loan, she simply takes over the existing mortgage payments. This is not a formal assumption of the loan; a buyer who cannot qualify for a conventional loan would probably not qualify for an assumption either. “Subject to” transactions generally make the most sense when there is little or no equity in the property.
Whether or not the buyer gets a new mortgage on the property, the seller always has the option to finance a portion of the purchase price herself. The buyer makes a cash down payment, the new or existing mortgage stays in first position, and the buyer gives the seller a promissory note for the difference. This can help save a deal where the buyer does not have enough of a down payment otherwise. The “seller second” could be combined with a “subject to” deal if there was substantial equity in the property (more than the buyer’s available cash for a down payment).
A wraparound mortgage is also a “seller second,” but works a little differently. Let’s say the property is worth $300,000 and the balance of the first mortgage is $150,000. The buyer has $30,000 for a down payment. Instead of carrying back a second mortgage of $120,000, the seller carries back a second mortgage for $270,000. The new second mortgage “wraps around” the existing first mortgage. The seller deeds the property to the buyer but continues to pay her first mortgage. The buyer pays the seller the down payment and the monthly payment on the new second mortgage, as if the seller is the bank. (In fact, the seller is the bank.) The wraparound mortgage can feature a balloon payment, so that the buyer can cash out the seller completely in 3-5 years. This is an attractive deal for the seller, who gets cash upfront (the down payment), cash every month (the difference between the two mortgage payments), and cash later (when the buyer gets new financing and cashes out both the original loan and the wrap).
All of these creative methods involve the transfer of title (the deed) without the payoff of the first mortgage. In most cases (and virtually always in a residential transaction), the first mortgage will contain a due-on-sale clause that gives the lender the option – but not the obligation – to accelerate the note and call the note due if the property is sold without the loan being paid off. The due-on-sale clause does not mean that these types of transactions are “illegal.” It is simply a protection for lenders. The presence of the due on sale clause has been known to cause much fear and trepidation in people involved with real estate transactions, even attorneys, but in practical terms, triggering the due-on-sale clause does not carry a large risk of foreclosure. Banks are in the business of lending, not owning real estate, and it is almost unheard of for a bank to accelerate a loan simply for a due-on-sale violation – so long as the loan is current.
Seller-financed transactions are subject to two federal laws – the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) and the Safe Mortgage Licensing Act (“SAFE”), both of which are designed to protect buyer-borrowers from unscrupulous lenders. A full rendition of the requirements of Dodd-Frank and SAFE is beyond the scope of this article, but both statutes create additional “hoops” for real estate buyers and sellers to jump through. Despite what you may have heard, neither law makes owner financing illegal, and indeed, they only apply to investors who close multiple transactions every year.
To make sure that you structure your creative real estate deals correctly and to avoid all of the legal landmines in the seller financing landscape, contact a Texas real estate attorney who has experience with these atypical types of transactions.