So, you're driving along and see a sign "For Sale By Owner, Seller Financing". You check your rear view mirror because you don't have a bumper sticker that says "Caution, I stop at FSBO signs" then slam on the brakes and pull into the driveway. You get out and check out the house looking in the windows and checking the outside. It all looks promising. Then you call the number on the sign. As a buyer, what do you say and do next?

Again, knowing what to expect will give you an advantage. Expect the property to be priced at a higher price as a premium for the offer of seller financing! When you hear the price don't baulk at it, they will come down! Ask the seller the usual questions. How long have you owned it, why are you selling, what problems are there and will you sell it for cash are just some of the questions that may give you clues about the property and the seller. Now ask if the seller really wants to sell it. This direct question will put the seller on the spot and the answer will likely be "yes", but other circumstances may be mentioned that will clue you in to the sellers' real motivation. Ask the seller if there has been an appraisal done and if you could see it. When you ask about an appraisal, the seller should know by then that this marketing strategy may not work with you, but they already committed to selling it. Now ask what the cash price is. The price should drop right there, before you even look at the property. Sometimes, the seller wants to sell but for tax purposes they want the financing option, if so, expect a per-payment penalty for early payoff.

Let's assume that the seller is selling under an installment contract, a Contract For Deed (CFD).  You need to ask if the seller intends to record the contract and if there is any underlying financing on the property. This is where you seperate the ethically minded seller from the tricksters! Regardless of the answers you need to recongnize your buying strategy at this point. Is this property a buy and hold, or is it a fix and flip?

Let's assume for this article your intentions are to fix and flip the property. If you recognize that the use or function of the property will yield you a higher price you may have a fix or rehab and flip deal. If you can go in a accomplish your goal in a short term, say three or four months, you could proceed regardless of what the seller was intending. But, you need to tell the seller what your intentions are to address any pre-payment penalty if one is considered. There is a way to accomplish your goal and keep the seller financing in place, by an assumption or assignment of collateral. As the buyer, after the contract is made, you can always record your interest even if the seller was expecting to do a shady deal. You may also inform the lender. Why? Because you will head off any future problems by using a disclosure discussed later. In some states, notice is required by law prior to executing a contract that provides an equitable interest to a buyer. If you are in a fix and flip startegy, you should be under a short time frame of ownership interest and your sale will probably be perfected prior to any action. You may proceed at your own risk. They may not give their blessing in writing, but they will probably agree to simply ignore your deal. Full disclosure is the way you should operate even if the seller does not!

Your contract term can be for a term sufficient for your intentions with a balloon payment as short as one year for a fix and flip. But, since things happen, you should still go for a longer term. Make sure the terms of your contract provide for improvements to be made to the property. Many contracts will have a referrence to "laying waste" to the property as a default provision. Your tearing out a wall could well be construed as damaging the property regardless of your intentions. Making reference in your contract to a set of plans and specifications for improvements is a good idea. Other contract provisions should be addressed as if your strategy was to buy and hold the property. Insurance is an important aspect of your deal.

A "CFD" usually has provisions for the buyer to obtain a policy of insurance and provide a loss payee clause on the declarations page of the policy. If it does not, ensure that it does! Most insurance companies have a rider allowing an owner to carry on remodeling of a property. This rider will cover related risks and exposures of construction and generally cover materials on site and liability exposures. They do not cover workmen's compensation or extended liability of contractors working for you, so check on these issues as applicable.

Contract servicing, recording and accounting for payments and escrowing for deeds is not as critical in a fix and flip deal as a buy and hold strategy, but it still is important. The seller should allow for deposits to be made by a buyer directly into a bank account as previously mentioned. Doing so will provide proof of payments made for the benefit of the seller and establish credit for underwriting your deal later if that becomes necessary. Always be in a position to swith strategies in the event of the unforseen.

If the seller insists on a pre-payment provision due to taxation, your CFD can be assigned to a new buyer with seller consent, with such consent not being unreasonably denied. This can be accomplished "with recourse", meaning that you will still be liable under the contract or "without recourse" with you being fully released under the obligation. Any assignment or assumption can be modified so that you may wrap your obligation to provide future financing to your buyer. If you agree to a contract with such provisions, you might consider doing so with recourse, remaining responsible. This allows three aspects for consideration. First your seller is more likely to agee to your buyer moving in under an assupmtion as their risk is not significantly increased, secondly, the same risk analysis holds true for any underlying note holder and lastly, you have an opportunity to earn an interest rate over that being paid to your seller, this is compensation for remaining liable under the obligation.

Other contract provisions will be addressed under a buy and hold strategy that will still be applicable for any CFD. As mentioned, your agreement should be accomplished with notice to any underlying mortgage holder. When I purchased or arranged such installment transactions, if I could not meet with the note holder, I got someone on the phone and informed them of the transaction. Notice that I said I informed them, I did not initially ask them! Initially, some lenders would tell me that we could not do that and I would simply say, "OK, but I'm sending you a disclosure and we can address that later in the event a contract is made". Then I would provide a written disclosure addressing the issues of the contract.

A memorandum or notice of proposed sale provided to the lender, either hand delivered or mailed with return receipt requested would be given to the note holder. This document discloses the following issues and concerns:

The parties to the proposed contract, the sale price, existing property conditions and a vague description of the underwriting issues addressed concerning the buyer. Some states require specific notices with statutory requirements. These underwriting issues were simply in a narrative form stating that credit as well as capacity have been addressed and that the buyer is capable of performance at the time of maturity of the agreement. The "due on sale clause" is specifically addressed in this disclosure and an acknowledgement of the provision is made.

A narrative explaining your position of the purpose and scope of the due on sale clause is made. While a lender may have a right to accelerate a mortgage the strategy is to show that it is not in their best interest to do so. Make ther argument that the purpose of the clause is to prevent any sale where the existing loan may be assumed under existing market interest rates which exposes the lender to an unacceptable interest rate risk. Then a declaration stating bascically that "considering current interest rates offed by the note holder, the amounts being assumed do not pose any such additional interest rate exposure". Additionally, an explanation that the exisiting borrower(s) is (are) fully aware that they remain fully liable for the amounts outstanding and the terms of the obligation remaining shall be kept.

This provides the basis of the argument that the lender is at no additional risk and in fact, having such a contract in place may increase the capacity of the borrower to meet the obligation. It also presents a defense in the use of the due on sale clause from a financial aspect and the underlying issue of preventing the borrower from not only making a profit, but also increasing the ability to repay the obligation.  This disclosure effectively puts the ball in the lenders' court. It outlines the issues at hand and provides a defense that may be difficult to overcome. This strategy as well as your contract should be reviewed by your real estate attorney.

I would allow a reasonable period of time (at least seven business days) for any objestion to be made by the underlying note holder, but I have never received one. Silence may be construed as acceptance. Additionally, many times I would include a copy of the CFD in its draft form. After seeing that all the bases were covered in the contract, a lender was assured that aspects of this transaction were being accomplished in a professional manner. 

Next time we will look at the CFD in a buy and hold startegy and additional buyer considerations.

Bill Gulley                                                                                 Financexaminer                                                                                American Realty Institute LLC