Dealing With the Due on Sale Clause
Dealing With the Due on Sale Clause
In the article There is No “Due on Sale” Jail, it outlined a basic strategy for using a revocable land trust to quietly circumvent the “due-on-sale” clause. The following is a strategy that can be combined to make a bundle of money with owner-carry mortgages and land contracts.
You are probably familiar with the basic strategy of buying homes with FHA or VA assumable mortgages, then selling the home for a few thousand bucks. The new buyer assumes the loan and you are out of the picture.
Some people like to buy the home, assume the loan, then sell it on an installment land contract (a.k.a. “contract-for-deed”). The payments collected on the ILC are usually higher, creating a nice monthly spread. The underlying loan is not assumed or paid off; the investor collects payments from his ILC buyer and makes payments on the underlying FHA or VA loan. This is commonly referred to as a “wrap.” The only problem with this strategy is the lack of assumable FHA and VA loans. All FHA and VA loans originated after 1989 are not freely assumable.
Buy In A Land Trust “Subject To” The Existing Loan
Let’s go back to the land trust strategy. Find a homeowner with no virtually no equity who needs to get out from under his payments. Basically, anyone who purchased a home with an FHA or VA loan in the last few years would qualify.
Let’s use an example. Seller has a home worth $100,000. He owes $97,500 on an 8.5% interest, 30 year loan. His payments are $925/month, P.I.T.I. (principal, interest, taxes and insurance). He just got divorced and he got stuck with the house. He wants out in a big way. The brokers in town are not thrilled with taking the listing because he doesn’t have enough equity for a 6% broker’s commission. He refuses to live there another day. With 50% of marriages ending in divorce these days, how many of these scenarios do you think you can find? Buy the home by taking title in a land trust, subject to the existing loan.
Place an ad in the paper:
No Bank Qualifying
Owner Will Carry
with small down
Your phone rings off the hook. You find a qualified buyer. “What are the terms,” he asks. You tell him the purchase price is $107,000. You ask for $5,000 down and you will carry a mortgage for $102,000 at 12% interest (yes, believe it or not, people with bad credit will pay inflated purchase prices and absurd interest rates. (If you don’t believe it, ask any car dealer in town!)
Here are the mechanics of the deal. Your trustee (of the trust that just took title to the property) will sign an installment land contract with your new buyer. Your trustee will collect monthly payments of about $1,225 per month. He will pay the underlying mortgage and disburse the net proceeds to you ($1,225 – $925 = $300 net to you). He will hold title until the buyer either sells the property or refinances and pays off the installment land contract. Until he does, you make a sizeable monthly profit (not to mention the fact that you made $5,000 up front).
Small Risk, Big Reward
What can go wrong? Well, three things. First the buyer can default, in which case you would have to make some monthly payments while you foreclose. The good news is that while you may lose a few bucks, you can sell it again for another $5,000 down, maybe more.
Second, the bank on the underlying loan could find out and call the loan due. This is not very likely, since payments are current. If the value of the property increased, you could always refinance the property yourself.
Finally, the seller could get tired of this loan being on his credit report and “conveniently forget” that you told him it would stay there. I’ve seen sellers come back years later and claim that they were somehow mislead. I’ve designed a special “CYA” form just for this purpose that I make them sign. I keep a copy in my file for my protection.
All investments carry some risk, otherwise there would be no reward. In the above example, you, the investor, put up no money, so you really have nothing at risk. In reality, the buyer on the installment land contract will eventually get tired of paying 12% interest and refinance the property. When this happens, you pay off the underlying loan and you are out of the picture.