Creative financing
Encyclopedia
Creative financing is a term used widely amongst real estate investors to refer to non-traditional means of real estate
financing, or financing techniques not commonly used. The goal of creative financing is generally to purchase, or finance
a property
, with the buyer/investor
using as little of his own money as possible, otherwise known as leveraging
, OPM
(Other People's Money). Using these techniques an investor may be able to purchase multiple properties using little, or none, of his "own money".
s (abbreviated as HML) are similar to private mortgages except that they are made through a hard money lender
. A hard money lender may get his financing either from his own contacts with private lenders, or financial institutions with whom he has established his own lines of credit
.
Hard money loans are made to real estate investors for the purpose of investing in and rehabbing real estate. Rates
are a little higher than borrowing directly from a private lender, as the hard money lender may also be collecting yield spread
. The hard money lender will also charge point
s of 3% to 6% or more. These points are often paid up front, but a few lenders may roll these into the loan.
Hard money loans are high-interest
mortgage
s available from private investors. Desperate borrowers with poor credit scores, bankruptcies
, no verifiable income, or too much debt
often take out hard money loans when they are unable to qualify for traditional mortgages. Hard money becomes a last resort when borrowers cannot meet the lending standards set by banks or government sponsored enterprises such as Fannie Mae and Freddie Mac.
is a loan
secured by real estate
that is made by a private lender, instead of a traditional lender, financial institution
, or government institution. These loans are most commonly short term and last anywhere from 6 months to three years. These are asset based loans made for the purchase and rehabilitation of real estate. Because the loans are asset based, the decision to loan is based on the criteria of the property and not usually the qualifications, or credit
of the borrower.
Interest rates on these loans are considerably higher than traditional loans and may range from 12% to 18%, with points sometimes being required as well. Loans are made on an LTV (loan to value
) of 65% to 70%, to preserve sufficient equity
in the property for the private lender in the event of default.
allows a home seller to offer owner financing on a property without having to hold any mortgage
. On closing day, the property title is transferred to the buyer and the newly created (owner-financed) mortgage is sold to a note investor for cash, simultaneously.
Once a property is acquired subject-to there are a number of exit strategies that the buyer can use to turn a profit if the deal is sound. The new note can often be used to produce a wraparound mortgage
and finance individuals that have a hard time getting a loan through a traditional lending institution. Certain states allow the buyer to enter into a lease/option agreement using the existing financing. The house can also be sold to a retail buyer or wholesaled to another investor for profit.
is an agreement whereby one party (the trustee
) agrees to hold ownership of a piece of real property for the benefit of another party (the beneficiary
). Land trusts are used by nonprofit organizations to hold conservation easements, by corporations and investment groups to compile large tracts of land, and by individuals to keep their real estate ownership private, avoid probate
and provide several other benefits.
In the application of creative financing, a land trust can be used to take control of a property while keeping the name of the owner private, which theoretically will avoid invoking the due on sale clause of the current deed of trust.
, the seller is often several payment
s behind and may even be close to foreclosure
, the seller can also show significant hardships that have led them to being unable to continue making payments on this property
. The seller will give the short sale investor a contract
to purchase the property, a deed
that will probably be placed in escrow
, power of attorney
and a number of other documents that will give them full control
of the property. The investor will then present a case to the bank
holding the mortgage
, that the seller is no longer able to make payments, is having to relinquish control of the property and that the loan on the property must be reduced in order for the investor to purchase the property.
The term "short sale" is a misnomer
because it has nothing to do with shorting anything in the financial
sense. These transactions can also take a significant amount of time so it is not called a "short sale" for that reason either. However, the process is shorter than the traditional process of going through foreclosure and sale by auction, which is still likely to take much longer.
This is a method to sell your house quickly, because effectively you pass over control of your property to the short sale investor immediately upon signing of the documents. From that time on, it is up to the investor to complete the transaction. Should a bank refuse to accept the investor's offer on a short sale, there is no guarantee that the house will not go to foreclosure anyway, but this does provide the seller a "possibility to avoid foreclosure", when all else has failed.
This technique may also be use to stop foreclosure
long enough to allow another purchase, or something else to be done with the property.
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
financing, or financing techniques not commonly used. The goal of creative financing is generally to purchase, or finance
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
a property
Property
Property is any physical or intangible entity that is owned by a person or jointly by a group of people or a legal entity like a corporation...
, with the buyer/investor
Investor
An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
using as little of his own money as possible, otherwise known as leveraging
Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:* A public corporation may leverage its equity by borrowing money...
, OPM
Other People's Money
Other People's Money is a 1991 drama/romantic comedy film starring Danny DeVito, Penelope Ann Miller and Gregory Peck. It is based on the play of the same name by Jerry Sterner. The director was Norman Jewison and the screenplay was credited to Alvin Sargent.-Plot:Corporate raider Lawrence...
(Other People's Money). Using these techniques an investor may be able to purchase multiple properties using little, or none, of his "own money".
Hard money loans
Hard money loanHard money loan
A hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by the value of a parcel of real estate. Hard money loans are typically issued by private investors or companies...
s (abbreviated as HML) are similar to private mortgages except that they are made through a hard money lender
Hard money lender
Hard money lenders are lending companies offering a specialized type of real-estate backed loan. Hard money lenders provide short-term loans that provide funding based on the value of real estate that has been collateralized for the loan...
. A hard money lender may get his financing either from his own contacts with private lenders, or financial institutions with whom he has established his own lines of credit
Credit (finance)
Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately , but instead arranges either to repay or return those resources at a later date. The resources provided may be financial Credit is the trust...
.
Hard money loans are made to real estate investors for the purpose of investing in and rehabbing real estate. Rates
Rates
Rates is a Portuguese parish and town located in the municipality of Póvoa de Varzim. In the census of 2001, it had a population of 2,539 inhabitants and a total area of 13.88 square kilometres.-History:...
are a little higher than borrowing directly from a private lender, as the hard money lender may also be collecting yield spread
Yield spread
In finance, the yield spread is the difference between the quoted rates of return on two different investments, usually of different credit quality.It is a compound of yield and spread....
. The hard money lender will also charge point
Point (mortgage)
Points, sometimes also called a "discount point", are a form of pre-paid interest. One point equals one percent of the loan amount. By charging a borrower points, a lender effectively increases the yield on the loan above the amount of the stated interest rate...
s of 3% to 6% or more. These points are often paid up front, but a few lenders may roll these into the loan.
Hard money loans are high-interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
mortgage
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
s available from private investors. Desperate borrowers with poor credit scores, bankruptcies
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
, no verifiable income, or too much debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
often take out hard money loans when they are unable to qualify for traditional mortgages. Hard money becomes a last resort when borrowers cannot meet the lending standards set by banks or government sponsored enterprises such as Fannie Mae and Freddie Mac.
Private mortgages
A private mortgageMortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
is a loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
secured by real estate
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
that is made by a private lender, instead of a traditional lender, financial institution
Financial institution
In financial economics, a financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries...
, or government institution. These loans are most commonly short term and last anywhere from 6 months to three years. These are asset based loans made for the purchase and rehabilitation of real estate. Because the loans are asset based, the decision to loan is based on the criteria of the property and not usually the qualifications, or credit
Credit rating
A credit rating evaluates the credit worthiness of an issuer of specific types of debt, specifically, debt issued by a business enterprise such as a corporation or a government. It is an evaluation made by a credit rating agency of the debt issuers likelihood of default. Credit ratings are...
of the borrower.
Interest rates on these loans are considerably higher than traditional loans and may range from 12% to 18%, with points sometimes being required as well. Loans are made on an LTV (loan to value
Loan to value
The loan-to-value ratio expresses the amount of a first mortgage lien as a percentage of the total appraised value of real property. For instance, if a borrower borrows $130,000 to purchase a house worth $150,000, the LTV ratio is $130,000/$150,000 or 87%.Loan to value is one of the key risk...
) of 65% to 70%, to preserve sufficient equity
Ownership equity
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists...
in the property for the private lender in the event of default.
Simultaneous Closings
A Simultaneous closingSimultaneous closing
Simultaneous closing is a real estate seller financing technique, whereby the private mortgage note created by the seller is simultaneously sold to a note buyer on closing....
allows a home seller to offer owner financing on a property without having to hold any mortgage
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
. On closing day, the property title is transferred to the buyer and the newly created (owner-financed) mortgage is sold to a note investor for cash, simultaneously.
Subject-to
A subject-to transaction is a creative finance technique where a buyer is able to take title to property without procuring a note of his or her own. The transaction usually involves the seller of the property leaving his or her existing financing in place so that the buyer does not need to pay transaction costs associated with obtaining a traditional loan. This process is similar to assuming a loan, but differs because it usually takes place without the consent of the original lending institution and violates the terms of the loan. This technique is useful because it affords the buyer the ability to obtain financing without the need for transaction costs and does not tie up capital to procure a new note. The technique also allows the buyer to purchase property quickly without going through the arduous loan process.Once a property is acquired subject-to there are a number of exit strategies that the buyer can use to turn a profit if the deal is sound. The new note can often be used to produce a wraparound mortgage
Wraparound mortgage
A wrap-around mortgage, more-commonly known as a "wrap", is a form of secondary financing for the purchase of real property. The seller extends to the buyer a junior mortgage which wraps around and exists in addition to any superior mortgages already secured by the property...
and finance individuals that have a hard time getting a loan through a traditional lending institution. Certain states allow the buyer to enter into a lease/option agreement using the existing financing. The house can also be sold to a retail buyer or wholesaled to another investor for profit.
Land trust
A land trustLand trust
There are two distinct definitions of a land trust:* a private, nonprofit organization that, as all or part of its mission, actively works to conserve land by undertaking or assisting in land or conservation easement acquisition, or by its stewardship of such land or easements; or* an agreement...
is an agreement whereby one party (the trustee
Trustee
Trustee is a legal term which, in its broadest sense, can refer to any person who holds property, authority, or a position of trust or responsibility for the benefit of another...
) agrees to hold ownership of a piece of real property for the benefit of another party (the beneficiary
Beneficiary
A beneficiary in the broadest sense is a natural person or other legal entity who receives money or other benefits from a benefactor. For example: The beneficiary of a life insurance policy, is the person who receives the payment of the amount of insurance after the death of the insured...
). Land trusts are used by nonprofit organizations to hold conservation easements, by corporations and investment groups to compile large tracts of land, and by individuals to keep their real estate ownership private, avoid probate
Probate
Probate is the legal process of administering the estate of a deceased person by resolving all claims and distributing the deceased person's property under the valid will. A probate court decides the validity of a testator's will...
and provide several other benefits.
In the application of creative financing, a land trust can be used to take control of a property while keeping the name of the owner private, which theoretically will avoid invoking the due on sale clause of the current deed of trust.
Short sale
In a short saleShort sale (real estate)
A short sale is a sale of real estate in which the proceeds from selling the property will fall short of the balance of debts secured by liens against the property and the property owner cannot afford to repay the liens' full amounts, whereby the lien holders agree to release their lien on the real...
, the seller is often several payment
Payment
A payment is the transfer of wealth from one party to another. A payment is usually made in exchange for the provision of goods, services or both, or to fulfill a legal obligation....
s behind and may even be close to foreclosure
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
, the seller can also show significant hardships that have led them to being unable to continue making payments on this property
Property
Property is any physical or intangible entity that is owned by a person or jointly by a group of people or a legal entity like a corporation...
. The seller will give the short sale investor a contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
to purchase the property, a deed
Deed
A deed is any legal instrument in writing which passes, or affirms or confirms something which passes, an interest, right, or property and that is signed, attested, delivered, and in some jurisdictions sealed...
that will probably be placed in escrow
Escrow
An escrow is:* an arrangement made under contractual provisions between transacting parties, whereby an independent trusted third party receives and disburses money and/or documents for the transacting parties, with the timing of such disbursement by the third party dependent on the fulfillment of...
, power of attorney
Power of attorney
A power of attorney or letter of attorney is a written authorization to represent or act on another's behalf in private affairs, business, or some other legal matter...
and a number of other documents that will give them full control
Control (management)
Controlling is one of the managerial functions like planning, organizing, staffing and directing. It is an important function because it helps to check the errors and to take the corrective action so that deviation from standards are minimized and stated goals of the organization are achieved in...
of the property. The investor will then present a case to the bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
holding the mortgage
Mortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
, that the seller is no longer able to make payments, is having to relinquish control of the property and that the loan on the property must be reduced in order for the investor to purchase the property.
The term "short sale" is a misnomer
Misnomer
A misnomer is a term which suggests an interpretation that is known to be untrue. Such incorrect terms sometimes derive their names because of the form, action, or origin of the subject becoming named popularly or widely referenced—long before their true natures were known.- Sources of misnomers...
because it has nothing to do with shorting anything in the financial
FINANCIAL
FINANCIAL is the weekly English-language newspaper with offices in Tbilisi, Georgia and Kiev, Ukraine. Published by Intelligence Group LLC, FINANCIAL is focused on opinion leaders and top business decision-makers; It's about world’s largest companies, investing, careers, and small business. It is...
sense. These transactions can also take a significant amount of time so it is not called a "short sale" for that reason either. However, the process is shorter than the traditional process of going through foreclosure and sale by auction, which is still likely to take much longer.
This is a method to sell your house quickly, because effectively you pass over control of your property to the short sale investor immediately upon signing of the documents. From that time on, it is up to the investor to complete the transaction. Should a bank refuse to accept the investor's offer on a short sale, there is no guarantee that the house will not go to foreclosure anyway, but this does provide the seller a "possibility to avoid foreclosure", when all else has failed.
This technique may also be use to stop foreclosure
Foreclosure
Foreclosure is the legal process by which a mortgage lender , or other lien holder, obtains a termination of a mortgage borrower 's equitable right of redemption, either by court order or by operation of law...
long enough to allow another purchase, or something else to be done with the property.