Is Creative Financing Becoming the New Subprime Lending?

[Steve K.]

Rising interest rates have hurt everyone’s buying power (except cash buyers obviously), and inventory is locked up because nobody wants to move and give up their historically-low interest rate. Word on the street is we’ll never see those rates again in our lifetime.

Having alternative strategies in your back pocket can be very helpful in putting deals together. That’s why more people are looking into different options such as seller-finance, subject to, wraps, lease options, etc. “Creative Financing” 

However, not many people are talking about the additional risks.

For example, with seller-financing: the worst case scenario is a buyer doesn’t make payments. No problem, seller has the promissory note and just takes the property back. Great, except “taking the property back” means foreclosing . Foreclosing sucks. It takes a long time and costs a lot of time and money. Plus, usually no payments are coming in during that time, the tenant(s) may need to be evicted, the property usually sits vacant and comes back in worse condition. Someone still has to cover taxes, insurance, and upkeep during the foreclosure.

Subject to is a similar half-truth: “If the bank exercises their right to enforce the due on sale clause, just deed the property back to the seller and use an executory contract: contract for deed, lease option, land contract instead.” But the bank usually still exercises their right to enforce the DOSC because title changing hands meets the bank definition of a sale. Also, each time you transfer the deed the IRS wants their cut. Not to mention closing costs. Not to mention that executory contracts don’t have the same benefits that sub to does because in a C4D the buyer does not have title and seller can easily cloud title or the seller can get a judgment against them or lien that attaches to the property. This can also cause issues with both title insurance and homeowner’s/landlord insurance. 

Every strategy has its appropriate time and place. But any sellers looking to "become the bank" should be vetting buyers like any other lender would. It doesn't seem like many are as creative financing becomes more mainstream.

$0 down deal structures with "infinite returns" are du jour. People are doing deals and capturing zero equity or cashflow, just to get properties with low interest rates, which is what we used to call being “over-leveraged". 

Too many owners being over-leveraged is what lead to massive foreclosures in the last big downturn 2008-2010.

Many buyers looking to use creative finance wouldn't make it through underwriting, which makes them sub-prime borrowers.

Is Creative Financing Becoming the New Subprime Lending?