AN ABBREVIATED HISTORY
OF CREATIVE FINANCING AND
The first form of financing was seller financing. The buyer would buy personal property or real property and pay the seller on an installment basis. Over time lending houses grew up, and purchase mortgages developed. Lending was local, done by bankers who knew what the land was worth and whether it was being properly managed.
The typical real estate mortgage in the United States was an interest-only loan with the full balance due in five years. Buyers set up bank accounts as a sinking fund to save up the money to pay off the mortgage after five years. When banks failed in 1929, buyers still owed their mortgages, but their savings accounts were lost.
During the Great Depression, the United States government institutionalized the 30-year fixed interest rate mortgage. Federal deposit insurance was introduced to get people to put their money into the banks.
As a result of our recent Great Recession, there are many properties on the market for bargain prices. But it is harder than it has ever been to get financing. The solution is not to get new financing. Instead use the seller’s existing financing. Do a lease-option or a lease with commitment to purchase or a wrap-around deed of trust transaction.
I got into real estate law back in 1980, when interest rates were the highest anyone can remember. Vietnam War deficit financing had pumped up the economy. Nixon had taken the country off the gold standard in 1971. The price of oil had gone through the roof. There was inflation at 13.5% per year and recession at the same time. It was called “stagflation.” Paul Volker took a sledge hammer to the economy, raising interest rates to the point where Jimmy Carter lost the election and home mortgage rates were in the teens.
People wanted to sell their homes, but buyers either could not qualify for mortgages at such high interest rates or were not willing to do so. Millions of sellers had old 3%, 4%, and 5% mortgages, and inventive real estate agents and lawyers figured out ways for buyers to assume their mortgages formally or informally. In some cases the mortgages had Paragraph 17 (renumbered today to Paragraph 18) due-on-sale clauses, which said that if the seller sold the property the bank could call the loan due. However, many state cases around the country held that due-on-sale clauses were void as restraints on alienation, practical impediments to resale.
I went into partnership with a Seattle attorney in 1980, and we were very busy writing and closing seller-financing transactions. Title companies and escrow companies were unwilling to close the transactions, and so we escrowed them ourselves.
Assume a $100,000 property (typical price back then) with a $60,000 deed of trust against it and a buyer with $30,000 in cash. The buyer would pay $30,000 down and give the seller an all-inclusive, wrap-around deed of trust for $70,000 that wrapped around and included the underlying $60,000 deed of trust. The buyer would make payments to the seller, and the seller would make payments to the lender. There would be a cash out in five years. Often we set up a collection account to handle the money, hold the original note and reconveyance, and give the seller notice if the buyer was not paying on time. Sometimes we got consent from the lenders. Sometimes we did not even ask for consent.
Then in 1984 Congress federalized the law of due-on-sale and preempted all state cases and statutes on the subject. Banks could enforce their Paragraph 17 or18 due-on-sale clauses and call loans due if there was a change in ownership. The bank had to give 30 days notice, and if the balance was not paid in full or the property was not deeded back to the seller, then the bank could conduct a foreclosure, a process that typically takes six or seven months. In the agreements we wrote, the buyer and seller agreed what they would do if the lender called in the loan.
There were exceptions to the new rule: The bank could not call in the loan if a parent deeded to a child, or a spouse deeded to a spouse, or if a borrower put title into the name of a trust and there was no change in possessory rights.
How does this relate to the present? Although interest rates are relatively low, it is still difficult for borrowers to get financing. That difficulty has had a significant impact on the current stagnation in sales and the drop in property values.
Maybe it is time for buyers and sellers to rebel. My experience is that lenders do not want to take properties back and will consent to wrap-around sales, provided that the seller is not released from liability. The banks have too many properties in their portfolios and mortgage insurance companies are being stretched financially.
I am ready and willing to set up and close wrap-around deed of trust transactions. The method I use is this: I either get the lender to agree to waive enforcement of the due-on-sale clause, or I get buyer and seller to acknowledge there is a risk, and I define the risk. I get the buyer to agree that if the lender calls the loan due, that the buyer will either refinance or resell the property.
What kind of buyer would be a likely candidate for a wrap-around sale? If I can get the lender to consent to the wrap-around, then any buyer would be a likely candidate.
If I cannot get a response from the lender or if the lender refuses to give consent, then the buyer candidate would be an investor or a person who could tolerate a certain level of risk, perhaps a person with sufficient assets who could refinance or re-sell the property if necessary. Every transaction would be handled differently.
If the parties or real estate agents still have some concern about the bank possibly foreclosing, I can put the deal together on a lease-option basis or a lease with commitment to purchase, in which case there is nothing the lender can know about the transaction. Payments can be made through a trusted collection agent. The deed can be held by the collection agent in true escrow. In order to give the buyer a recorded interest in the property, I record a custom drafted document which does not constitute a sale and yet protects the buyer.
I get calls from all over the country. However, I am licensed to practice law only in Washington. Nevertheless, I will work with parties in states other than Washington, provided they have counsel in their home state who can “sponsor” me and provided laws in the home state allow out-of-state attorneys to be sponsored.
I give initial telephone consultations to real estate agents and buyers and sellers by telephone for no charge. I generally represent the buyer. I advise the listing and selling agent to put together a purchase and sale agreement using standard seller financing deed of trust forms and to add the following provision to the agreement: “At this stage this document is a letter of intent only. It will remain such until it has been reviewed and amended by legal counsel and the amended document is signed again buy the buyer and seller.” I include language which acknowledges that the buyer and seller have consulted with legal counsel and will not hold the real estate agents liable.
Bank regulators should require banks to allow buyers to take over sellers’ existing mortgages in order to spur home sales. Due-on-sale clauses should be disregarded and assumptions and wrap-around sales should be allowed until the housing and mortgage markets return to normal. Click here to read the letter I wrote President Obama regarding this issue.
Until such change is made, buyers and sellers can be creative and “go around” due-on-sale clauses.