Underwater Solution Help

[John Matthews]

Hey BP,

A friend of mine is a bit underwater on their home in Phoenixville, PA. They bought it in 2009 for $173k and it's worth about $150k with about $150-155k left on the loan. They need to move in another year or so. So I'm trying to think of solutions that work for them without having to put money up to get rid of the place.

Rent in the area for that property type is about$1350/mo. So with a mortgage payment of about $850/mo it doesn't quite make sense to rent it out - it'd be negative $150/mo.

My thought is that she sells the home, sub2 with a seller finance wrap around her existing mortgage to an end buyer. I could get the buyer to put down 20%, and pay 6% and still keep up with her mortgage payments, but the home would need to sell for about 10k above what it might be worth. The other thought is, if she's not interested in dealing with potentially foreclosing I do basically the same thing, but instead she sells it to me sub2, then I sell it to an end buyer with a wrap around seller finance, so I have the right/obligation to foreclose if the buyer defaults. Obviously she's not as well protected in this scenario though.

Hopefully that makes sense...But I've got a few questions.

1. Would a seller finance note sufficiently protect the lender and give them the right to foreclose if necessary?

2. Is it unreasonable to think that someone would buy a seller finance home ~5-10% above market?

3. Is 6% interest unreasonable on a seller finance home with 20% down?

4. Legally are there any issues with selling the home like this in the area? How about if the seller finance monthly payment is $50-$100 more per month than her existing mortgage payment?

5. Am I making this too complicated? Is there a better solution to her problem?

Thanks for your help!

[Dion DePaoli]

Originally posted by @John Matthews:

Hey BP,

A friend of mine is a bit underwater on their home in Phoenixville, PA. They bought it in 2009 for $173k and it's worth about $150k with about $150-155k left on the loan. They need to move in another year or so. So I'm trying to think of solutions that work for them without having to put money up to get rid of the place.

Rent in the area for that property type is about$1350/mo. So with a mortgage payment of about $850/mo it doesn't quite make sense to rent it out - it'd be negative $150/mo.

My thought is that she sells the home, sub2 with a seller finance wrap around her existing mortgage to an end buyer. I could get the buyer to put down 20%, and pay 6% and still keep up with her mortgage payments, but the home would need to sell for about 10k above what it might be worth. The other thought is, if she's not interested in dealing with potentially foreclosing I do basically the same thing, but instead she sells it to me sub2, then I sell it to an end buyer with a wrap around seller finance, so I have the right/obligation to foreclose if the buyer defaults. Obviously she's not as well protected in this scenario though.

Hopefully that makes sense...But I've got a few questions.

1. Would a seller finance note sufficiently protect the lender and give them the right to foreclose if necessary?

2. Is it unreasonable to think that someone would buy a seller finance home ~5-10% above market?

3. Is 6% interest unreasonable on a seller finance home with 20% down?

4. Legally are there any issues with selling the home like this in the area? How about if the seller finance monthly payment is $50-$100 more per month than her existing mortgage payment?

5. Am I making this too complicated? Is there a better solution to her problem?

Thanks for your help!

Well you asked some good questions for this topic and that is refreshing.  

1.  Can a properly originated and perfected mortgage held by the Seller foreclose on the property in the event of a breach or default?  Yes.

Now the issue you may run into is, if you finance in equity and not cash you may not be eligible for cash as a result of your foreclosure only the equity.  Meaning possession is returned to you.  This would inadvertently create a situation where you could foreclose on your Borrower and the underlying Mortgagee could foreclose on you.  You would have a right to redeem the property by paying in full but you would have be able to obtain cash needed, say through some arbitrage of what is owed and property value, to use to help pay down or off the underlying Mortgagee.  Failing to pay off that Mortgagee would mean you loose the property and your investment as they foreclose you out.  

That foreclosure is a foreclosure that links to the original Borrower. The lady you did a Sub2 with. So her credit would be damaged.

2.  Financing real property does not add value to the real property itself.  Financing an inflated property value can be deemed predatory or deceptive loan practices and get you in hot water.

3.  6.0% is probably a little low on the Seller finance spectrum of rates.  However, it would be contingent on other factors like any other loan including down payment, credit, occupancy and income & assets, etc.  That rate would not be bad for the right borrower who is sort of a just miss from a conventional loan stand point but probably 2.0% below where a 'troubled' borrower may need to be to offset lending risks.

4.  Lining up mortgage payments like you would be wanting to do is not as simply as adding up the spread between Payment A and Payment B.  Since those payments pay down principal at different rates depending on where they are in the amortization schedule you have to align that or you may end up with one loan coming to term creating a pseudo balloon event in the other.

5. There is not much you can really do here I don't think. To line these mortgages up for the sake of all involved you would have to apply the down payment of $30k plus 3 years of interest to the underlying mortgage just to get to a spot where you have mitigated your risk and your borrower's risk of loss in the event the underlying loan is called. So you would essentially collect $58k and pay it out to the underlying Mortgage while not making much of anything. That would bring the loans in line with each other better and on-going balance maintenance would have you loose a little bit of yield each year depending on how seasoned (old) the underlying loan is.

Now, that is likely not a good deal for you, an uninterested third party but could be a win/win for the actual Borrower lady you are trying to help. All that said, it is a fair amount of work and administration. Yet it could help her avoid potential default and foreclosure if the path starts to head that way.

However, the smart easy place to start for her is to contact her Mortgage Servicer and inquire about a short sale under the hardship of having to move out of state for work. With 12 months left until the moving deadline, I would start this process now and if need be rent for a month or two or make arrangements with a new buyer (provided the Mortgagee allows it) to stay until the right time. Moral of the story, start the process now.

As to you profiting from this. Like I said, probably not much here for you that is worth getting involved in. The home is too far upside down causing the solution to be too far out in time to make it worth while. 

[Dion DePaoli]

Originally posted by @John Matthews:

Hey BP,

A friend of mine is a bit underwater on their home in Phoenixville, PA. They bought it in 2009 for $173k and it's worth about $150k with about $150-155k left on the loan. They need to move in another year or so. So I'm trying to think of solutions that work for them without having to put money up to get rid of the place.

Rent in the area for that property type is about$1350/mo. So with a mortgage payment of about $850/mo it doesn't quite make sense to rent it out - it'd be negative $150/mo.

My thought is that she sells the home, sub2 with a seller finance wrap around her existing mortgage to an end buyer. I could get the buyer to put down 20%, and pay 6% and still keep up with her mortgage payments, but the home would need to sell for about 10k above what it might be worth. The other thought is, if she's not interested in dealing with potentially foreclosing I do basically the same thing, but instead she sells it to me sub2, then I sell it to an end buyer with a wrap around seller finance, so I have the right/obligation to foreclose if the buyer defaults. Obviously she's not as well protected in this scenario though.

Hopefully that makes sense...But I've got a few questions.

1. Would a seller finance note sufficiently protect the lender and give them the right to foreclose if necessary?

2. Is it unreasonable to think that someone would buy a seller finance home ~5-10% above market?

3. Is 6% interest unreasonable on a seller finance home with 20% down?

4. Legally are there any issues with selling the home like this in the area? How about if the seller finance monthly payment is $50-$100 more per month than her existing mortgage payment?

5. Am I making this too complicated? Is there a better solution to her problem?

Thanks for your help!

Well you asked some good questions for this topic and that is refreshing.  

1.  Can a properly originated and perfected mortgage held by the Seller foreclose on the property in the event of a breach or default?  Yes.

Now the issue you may run into is, if you finance in equity and not cash you may not be eligible for cash as a result of your foreclosure only the equity.  Meaning possession is returned to you.  This would inadvertently create a situation where you could foreclose on your Borrower and the underlying Mortgagee could foreclose on you.  You would have a right to redeem the property by paying in full but you would have be able to obtain cash needed, say through some arbitrage of what is owed and property value, to use to help pay down or off the underlying Mortgagee.  Failing to pay off that Mortgagee would mean you loose the property and your investment as they foreclose you out.  

That foreclosure is a foreclosure that links to the original Borrower. The lady you did a Sub2 with. So her credit would be damaged.

2.  Financing real property does not add value to the real property itself.  Financing an inflated property value can be deemed predatory or deceptive loan practices and get you in hot water.

3.  6.0% is probably a little low on the Seller finance spectrum of rates.  However, it would be contingent on other factors like any other loan including down payment, credit, occupancy and income & assets, etc.  That rate would not be bad for the right borrower who is sort of a just miss from a conventional loan stand point but probably 2.0% below where a 'troubled' borrower may need to be to offset lending risks.

4.  Lining up mortgage payments like you would be wanting to do is not as simply as adding up the spread between Payment A and Payment B.  Since those payments pay down principal at different rates depending on where they are in the amortization schedule you have to align that or you may end up with one loan coming to term creating a pseudo balloon event in the other.

5. There is not much you can really do here I don't think. To line these mortgages up for the sake of all involved you would have to apply the down payment of $30k plus 3 years of interest to the underlying mortgage just to get to a spot where you have mitigated your risk and your borrower's risk of loss in the event the underlying loan is called. So you would essentially collect $58k and pay it out to the underlying Mortgage while not making much of anything. That would bring the loans in line with each other better and on-going balance maintenance would have you loose a little bit of yield each year depending on how seasoned (old) the underlying loan is.

Now, that is likely not a good deal for you, an uninterested third party but could be a win/win for the actual Borrower lady you are trying to help. All that said, it is a fair amount of work and administration. Yet it could help her avoid potential default and foreclosure if the path starts to head that way.

However, the smart easy place to start for her is to contact her Mortgage Servicer and inquire about a short sale under the hardship of having to move out of state for work. With 12 months left until the moving deadline, I would start this process now and if need be rent for a month or two or make arrangements with a new buyer (provided the Mortgagee allows it) to stay until the right time. Moral of the story, start the process now.

As to you profiting from this. Like I said, probably not much here for you that is worth getting involved in. The home is too far upside down causing the solution to be too far out in time to make it worth while. 

[John Matthews]

@Dion DePaoli

Thanks for the response. That’s really helpful. I’ve got a few followup questions:

• 1.Typically how to people who seller finance or sell sub2 get around the risk of being foreclosed on when they foreclose? Or do they not, and just either accept the risk and/or hope they’ve got cash reserves just in case? Is there any way to protect one's self in the event of a default on a seller finance note without triggering the original mortgage foreclosure process? The only thing that comes to mind is a lease option type deal, where if they default, they just get evicted.
• 2.If I understand lining up the mortgages correctly, it’s only really necessary to line them up so the principal of the second (seller) mortgage is equal to or higher than the owner mortgage if the end buyer decides to pay off the loan early, correct? My thought was to set the seller mortgage to have equal to or more periods left than the original mortgage, and also have a higher monthly payment. If there's no funny business, I would think it's as simple as saying "since there are an equal number of payments left, and one is higher than the other, you're good" but obviously this doesn't hold true if the seller refinaces out of the seller finance loan at a point where their principal is actually lower than the original borrowers principal. Am I understanding this correctly?
• 3.With all of that said, it seems like the main risks are being foreclosed on after foreclosing…, avoiding predatory loan practices and having the loans misbalanced so if the 2nd loan gets paid early, there’s a pseudo balloon payment I need to pay. Am I missing anything else?

In theory I could take over the property sub2, then lease option the house with terms that the sale is done on seller finance once the loan is paid down sufficiently as above…risks here being that I would have to put money into the property every month until that happens…I’ll talk to her about starting the short sale process…

[Brian Gibbons]

@John Matthews

Underwater homes where PITI that does not match rent amount are tricky business deals

I never do sub 2 then wrap, only sub2 and lease purchase

If the PITI matches rent in a slightly underwater like 5% underwater then maybe look at it

The desirability of the house itself and its neighborhood is really the biggest thing I look for

Underwater houses take in a lot of factors

If the sellers are willing to contribute a payment say $200 a month to protect their credit and rent the property out on a lease purchase for market rent and offer a sales price that is based on appraisal,  and if that appraisal is lower than mortgage payoff, renew lease purchase, seller  continues to pay  the additional 200 per mo for another year toward principle and accept rent

The damage to credit with strategic default or short sale is usually quite serious, see www.myfico.com

See the amortization schedule to see how much principle is paid monthly vs interest in the current and near future years

[John Matthews]

@Brian Gibbons

I'm thinking about proposing that option as well. I think it makes the most sense. She either puts up $10k (or whatever it is) to preserve her credit NOW or she pays $200/mo for the next year, two or three, whatever. Even if she had to continue paying it for a full 50 months, she'd still be above putting up the $10k now considering at those terms she's basically getting an interest free loan.

In this case the PITI is about $1100 and rent is about $1300, so it's positive, but I get the feeling that they would feel better just paying $200/mo toward the principal (I think that's about where they're at in their amortization schedule) than they would forking over $1000 to replace the hot water heater, but I guess that's details...

Brian - Why don't you do sub2 and never wrap? For the risks mentioned above? Do you never sell on land contract in the first place?

[Brian Gibbons]

Hi @John Matthews

My thinking is interest rates are going up and increases "due on sale risk" on loan being called

Exit strategy is always lease purchase or lease option :)

[John Matthews]

@Brian Gibbons

Fair enough. It's certainly a safer bet in some cases. I do like the idea of residual income through seller financing though...

[Brian Gibbons]

Get residual by 

1) private 1st mortgages 6 % when buying

2) installment sales private 1st mortgages on free and free and clear houses when buying

And rent out