Seller's financing - ARM, ideas on future interest rate?

Question

Hi,

even though I really didn't want to, in the end I had to accept a condition of the seller to have adjustable rate on the seller's financing. There is a 4 year balloon, so I just hope that the interest rates won't skyrocket now.

Do you have experience with having seller's financing with ARM? Is it so unusual?

And one curious questions, do you think that the inflation will run high and therefore the interest rates will skyrocket in the next couple of years? Just wondering what people here expect.

Account Closed · Answer

John,

Have you have a chance to review your seller's promissory note to her bank? Residential properties more than 4 units are usually considered as commercial property and commercial loans are usually set to balloon in 3, 5 or 7 years even if they are amortized for 15 to 30 years. Many commercial loans are defaulting now because those loans are ballooning and the borrowers could not refinance because of their credit, property value, and other factors that prevent them from getting a new loan.

Your concerns to the property should include the interest rate, cash flow, value, time that you have to pay off the seller, and your personal credit. There should be enough cash flow from the property that you can use the income to pay your monthly payments, and to set aside a reasonable amount so that in the 2 year period that your bank requires the documented income you can save up at least 25-30% down payment plus conventional closing cost. You should make effort to purchase the property with a new loan so that you could have better control of the deal.

Account Closed · Answer

even if her amount is allowed to go way up to 36%, i would think/hope there is a cap on how much it can increase each year, or whenever it resets...is this the case?  if so, joon is right--the sooner you can get this refinanced the better...that being said, are you interested in this deal bc of the numbers or the owner financing?  if the owner owes too much, and that is why she's financing, you're not going to be able to refi in a few years..the property will need to appraise

Account Closed · Answer

this is not unusual..the most important thing to address now is how the new interest rate will be decided on...if you're buying, i'd request a cap that the interest rate can not exceed..if you're the seller, i'd put in something along the lines of "it will adjust to __ points above prime...youcan fill in the blank...and yes, i do expect interest rates to go up in the next decade....we are printing a ton of money, and in my opinion, interset rates are so low that they can only go up from here

John K. · Answer

I will post the exact terms later, if you guys are interested. However I am waiting for the seller to finally sign the contract today (the thanksgiving last week slowed the process down), and therefore I don't want to talk here about all the details.

Anyway, I should have quite high margin of safety, even if the interest rates would double in 3 years. If there would be hyperinflation, then I am screwed, but I think I wouldn't be the only one. ;o)

And Bryan, I did contact her bank and asked about the cap. Here is the funny answer from them:
"Her cap on the interest rate is 36%, but do not worry, the interest rates in last 40 years didn't get over 12%."

I was laughing, when the bank was so assuring me about not getting over 12%, but still having made her cap on 36%.  :D

Bryan Hancock · Answer

It is perfectly reasonable for the seller to want an ARM if you are wrapping around an ARM.  ARMs aren't always bad if you can get a small bump above some stable index for the fully-indexed rate.  An added benefit is that the payments decrease when the loan adjusts if you prepay the mortgage to maintain the same amortization period.  Consequently, you can use some of the cash flow from the project to prepay the mortgage if you can't get the exact financing you want so that your payments will adjust south as time goes on.

Rates are almost certain to rise because they are ridiculously low.  This really doesn't matter...what matters is if you have sufficient margin in your worst-case rate to still have positive operating leverage.

Is this the case?

Account Closed · Answer

what are the terms of the deal?

Bill Gulley · Answer

Bryan, off the top of my head, it's contained in the preditory lending law, referenced in the SAFE Act and also referenced in the CFPA.

The difficulty, IMO, is looking to the intent of the law, any law, while it is stated at the beginning of each law ( and breezed over by most readers, IMO) you can see how inter-twined legislation becomes. The SAFE Act has caused several old statutes to be amended, including the TIL, which discloses how ARMS will be disclosed.

Also, I didn't mention, that an ARM will need to be disclosed by it's estimated APR, and following that requirement leads you to the requirement that the APR is to be computed within one tenth of one per cent for the required term. First of all, while there are computer programs available to do this, not all are correct to this extent. As to calculators, to my knowledge, the are only two, the Texas Instruments BA II and the Hewlett Packard 12C (I think it is). So doing any ARM will need to be disclosed within this tolorence and frankly, most seller won't be able to comply with the math required!

Bryan, nothing is simple in financial regulations. And everything is regulated in finance, especially now. Hope that helps your research.

Bryan Hancock · Answer

Do you have a link for this Bill?  A statute?  I would like to learn more about it...must be new.

Bill Gulley · Answer

Not to rain on your parade but seller financed ARMs are now regulated. The index shall be the ten year T Bill, margin no more than 2 1/2% as I recall, floor is entry rate and ceiling I don't recall. A wrap is not to be over 2% of the underlying obligation. The loan must be fully amortized and any balloon payment required is restricted based on the amount of principal reduction by the amortized payments. The loans may not have a pre-payment penalty.

The pre-payment has been a popular covenant to pay the tax liability that becomes due arising from an early payoff. A legitimate issue, but no longer.

These restrictions are listed in the HUD guidelines for originated and are enforced by the appropriate regulators to the originator. They may veary state by state as may be approved by that regualtory agency overseeing those loans.

At issue too is that there is a difference between money loans and equity loans. What is usually missed here, IMO, is that many investors financing deals may try apply cash loan rules to equity loans. They are different as the equity loan is considered an installment sale, regardless of title being transferred as with a note and deed of trust vs a contract for deed....it's irrelevant.

Bonafide commercial deals are exempt. Remember too, that it is the secured property that defines the type of loan, being commercial or residential, not the fact that you have a business enterprise or that the property will be owned by a business entity. Check you state laws and your attorney.

Since the SAFE Act is in effect John, I suggest you check with the Kansas Department of Finance, RE Division and run your note by them before you do your deal.
Good luck.

Bryan Hancock · Answer

Nice reports...I don't have time to study them right now, but if your numbers are close it looks like a great investment!

I am glad to see the 50% emperor truly has not clothes!

Estimating the financing post balloon is extremely risk IMO and could blow the whole analysis.  If you don't have a prepay I would highly recommend trying to refinance asap while rates are still low!

Seller's financing - ARM, ideas on future interest rate?

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