This has to be a doozy of an idea: Is this even Legal?

Question

2 properties for sale in the same neighborhood. 1 is 45,000 the other is 49,000. Tax assessment of both is 10,000 lower that the asking price. The offer made is: He, (the owner) will sell both for &5,000  cash and co-sign a loan for 80,000. After receiving the loan, I give the owner $75,000 and he pays closing. The  extra 5,000 is for general expenses and emergency repairs. Once the transfer of title is complete, I put both houses on the note as collateral and release the home-owner-co-signer. Is that even legal?

Mike H. · Answer

Yea. That is the disconnect for me on this proposal.

I do believe the bank would let the seller co-sign on the loan. After all, they don't care if the seller is on the hook as long as the seller has good enough credit/assets to qualify.

The problem I see with that, though, is that I don't think you will be able to remove the seller from the note. If your DTI ratio is too high, its too high. You won't be able to refi these houses with a bank just because you own the house -  and thats the only way I know of that the bank will allow you to drop a co-signer from the loan.

So the seller is going to be stuck on that loan until you can qualify for a refi.

And the other issue is that most banks are not going to allow you to do one note on two houses. You would need to do two separate notes.

Also, if the seller did seller financing on 89k, your payments would be how much? $595 apiece for each house? So 1200???

What kind of terms is he offering on the seller financing? 15%?????

None of it really makes sense to me. Sometimes a deal just isn't a deal. And, in this case, its probably best not to jump into something like this with so many moving parts and so much confusion. At least not for someone so new to investing.   That doesn't mean experienced investors can't run into confusing stuff too though. It happens all the time.

But I would be hesitant to recommend doing anything with this unless and/or until you have a better understanding of whether this really is a good deal and how the seller is actually expecting this to work.  Because I don't see any way that you are going to be able to get his name off the loan any time soon.

Michael Seeker · Answer

@Cecil Russell - this doesn't make any sense at all.  In order to get a loan, you have to have collateral to back it up.  In this case, it would be the 2 houses.  A bank isn't going to give you a loan with the seller as a cosigner and they're also not going to just give you cash so you can "pay cash" for the houses.  Assuming you qualified, they would lend you up to around 80% of the purchase price which would be provided directly to the seller at closing.  What he is proposing will not fly with a bank and it sounds like his owner financing terms would cost you a ton of money in negative cashflow every month (on average).  I'd stay away from this person and deal...doesn't sound like there's any potential to do well with it.

Bill Gulley · Answer

Well, it's not illegal, but it's also not a good idea. I assume the seller knows he can get a signature loan or pledge other collateral, in your name as the primary and he being the co-borrower or guarantor, that's fine. If I did that my buyer might take off to Mexico before closing!

Next, he's still facilitating a sale, so long as the lender knows the use of funds and he can pull it off, fine, but it's probably something the lender would suggest not doing.

If he takes no security interest in the property, you default, he's on the hook and the property can got to foreclosure if the lender accepted the collateral. The question is, would they swap collateral, no on several fronts.

Or, he pays the loan off and would have to sue you, but he's got no interest in the property, he may force sale or accept the deed. If he forces sale it may not bring sufficient amounts, he has little recourse to collect from you, if it sells for more you get the overage after costs.

Already pointed out above the LTV, the purchase was within a year they will look at the lower of the purchase price or appraised value. Any bank examiner will see this as a ploy to evade prudent lending practices and other issues. Next, the bank won't release the golden egg borrower, the loan is based on his credit and ability to pay.

I haven't seen many sellers this motivated and stupid.

Here's a better way, form an LLC, he puts the property in the company. You and he are partners, your contribution is labor and management. Then after obtaining a loan at what ever cash he can get to the LLC, you buy the partner out under the Operating Agreement and being responsible for the LLC debt paying from your interest earned from management and your half of income proceeds. See your accountant. If you fail to perform he has recourse under that sale of the LLC interest. The bank makes the loan to the LLC, no due on sale clause issue with purchasing the LLC interest. He has the right to take control of the company as a partner if you fail to pay. He continues paying the loan and the is no foreclosure issue, he owns the property administratively under the Operating Agreement.

Check on transfer taxes, you may have them in transferring an interest in the LLC as the owner of the property.

He get cash and probably additional payments from you, it's a buy out of the LLC rather than a Dodd-Frank issue, but that's not to say the powers to be couldn't call it a method employed to avoid the Act, another aspect is there is nothing else in the LLC, it's not really a going concern, but there is nothing illegal about accepting payments from a partner buying you out, it's is a commercial loan which avoids the issues with the Act.....it could only really be questioned if you were to reside in the property. All should be good.

You need an attorney to draft this concept and the buy out. You also need safeguards in the Operating agreement, power of sale of assets, so the property can be sold, him paid off, proceeds going to you of any excess and the termination of the LLC. It is more involved, but when you lack credit and capital the only thing you have to offer and earn your way in is with labor and management. The 4 principles of economics, land, labor, capital and entrepreneurship. Takes 3 of the 4 to make a deal.

I would not proceed down the road initially suggested!!!! That will end up in a mess. :)

Wayne Brooks · Answer

Some things make no sense, but I don't know if it's a total scam yet.  I am assuming you stated the situation correctly, and didn't mix any things up.

Who is going to loan the $80k on this $85k purchase?

"Once the title transfer is complete..."  You don't put the houses "on the note as collateral", the lender will be having you execute a mortgage simultaneously with funding the loan/title transfer.

And, You can Not release the seller as a guarantor on the loan, only the mortgagee can.

It's sounds either mixed up, or some type of fraud.  This was the Seller's idea?

Dawn Anastasi · Answer

Why involve the owner on a loan and why not just get a partner that you already know and can vet and agree to?

Cecil Russell · Answer

Mr. G; going to go to Amarillo College. Closest to me and probably less expensive as I know to buy my books used at Amazon-if available. That's where I bought Principles of Real Estate I & II. I'm starting with business financials then real estate & mortgages with whatever else I need to learn. Classes are 3 hours each, which where combined with the knowledge available on BP, I will get a really good education in a brand new field. Been a trucker for 31 years. I'm tired of the long hours and low pay.

Bill Gulley · Answer

Dodd Frank applies to consumer lending, not commercial transactions. Any financing arrangement with any person who occupies a property as their residence is a consumer and such contracts are subject to financing restrictions under Dodd Frank.

Transactions between business partners where one partner is financing the business interest of the other partner(s) is not a consumer financing arrangement and Dodd Frank will not apply. However, it's not the wild west, business transactions are covered under federal laws, the Uniform Commercial Code (UCC), Security Exchange Commission (SEC) are usually the most applicable to real estate investors but there are various federal rules, regulations and laws that may apply.

Predatory lending or dealing is much more critical of consumer transactions than business transactions as those doing business are seen as more astute, each having the ability to deal in their own best interests. Matters of conflict that reach courts may be viewed in light of the sophistication of the parties, their experience and knowledge. If I were to coax a newbie into some transaction and my contract favors me unfairly, where a reasonable person having been informed would not enter into such a transaction and I just cleaned the guy's clock financially, I could be hammered.

Issues of fraud and deceptive trade practices certainly apply to commercial transactions, crossing lines can lead to other criminal charges, wire fraud is a popular charge applied as funds are usually transferred, if the mail was used in connection with the activity, mail fraud charges may be brought.

When people don't have business experience or really understand underlying financial matters and try to be creative because, for one reason or another they can't perform under usual and customary practices they expose themselves greatly to scrutiny, it only takes a complaint to the right person to uncover mistakes. Good intentions are very hard to prove when there is evidence to the contrary stemming from the not knowing or lack of awareness.

Good to hear you're going to school Cecil, but what school?

Cecil Russell · Answer

That was close Mr. pohl but I've decided not to try this until I have more experience to draw from. Thanks for the suggestion. I'm just too green to put myself in a situation that I don't know what I am doing.

Bill P. · Answer

@Cecil Russell

Using a Lease to own to own method is a harder process than most of the rest of the country because of Texas law.

If I am reading you correctly, the seller is willing to apply for the loan with your name and he cosigns for the loan. The title goes into your name. He gets the cash (except for $5K) and both of you are on the title. At some point in the future, you refinance in your name only and you each go on your merry way. It seems to be perfectly legal as long as all parties are aware of the transaction. He effectively gets a sale and you get properties with no money down. I think there can be some inherent problems with this scenario if you fail to make payments or you find problems with the houses after you buy them that cost more than $5K. But as long as everybody's eyes are wide open and the process is like I am reading it, it should work as long as a bank will do the purchase the way you want. Just my reading your question I think the way you wrote it.

Cecil Russell · Answer

Mr. Bill G: Separate question: With the advent of Dodd-Frank, is the LLC route the "better" way to go in operating a "Lease with Option to Buy"? I'm considering going back to school to enhance my knowledge of real estate/finance and I'm wondering if the LLC route would legally by-pass Dodd-Frank for small business investors? I hope you can understand my question but as I really am inexperienced, I don't know enough yet to even know if the question makes sense.

This has to be a doozy of an idea: Is this even Legal?

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