What You Need to Know about Creative Real Estate Financing

The bursting of the “housing bubble” in 2008 and the resulting credit freeze have made it harder for everyday Americans to qualify for residential loans. As a result, many prospective buyers are turning to creative financing options in their quests to purchase homes.

This scenario is not new. According to Arizona State University Professor Anthony Sanders, “Many of the new mortgage products that are surfacing are […] variations of mortgages that were popular during the high-inflation, high-interest-rate period of the late 1970s and early 1980s.” At that time, many people simply couldn’t qualify for a home loan from a traditional banking institution. High mortgage payments required greater cash flow and a larger down payment – not to mention increased mortgage origination fees – which most people, especially first-time home owners, simply couldn’t afford.

In 1982, the Federal Reserve Bank of Atlanta funded a Georgia State University Department of Economics survey of realtors across the American Southeast. These realtors provided information on more than 300 home sales that had closed that year. Upon reviewing the data, the authors of the study, Donald L. Koch, Delores W. Steinhauser, and Keith R. Ihlanfeldt, discovered that a stunning 53 percent of all transactions involved creative financing.

What is creative financing?

A popular choice during economic downturns, creative financing refers to any financial arrangement regarding a real estate transaction that doesn’t involve a traditional financial institution. The most common form of creative financing is a seller carrying a home loan for the buyer at a below-market interest rate.

Sellers who own their home outright and want to finance borrowers themselves can use a mortgage or a trust deed, although laws differ in each state about whether to record a mortgage or a trust deed. For example, in California, people use grant deeds for titles and trust deeds for promissory notes.

History of creative financing

In the 1960s, 1970s, and early 1980s, creative funding scenarios could include a developer or builder, or a buyer’s employer, providing the money. Less frequently, a realtor could hold the mortgage. Sellers could also rent or lease their homes with an option to buy.

The trouble with creative financing during this period was that in providing financing, sellers tended to focus more on just making a sale than they did on making a smart investment. This led them to ignore many of the basic principles of lending when constructing the deals.

However, since the passage of the Dodd-Frank Act in 2010, many creative financing options are no longer legal. Realtors today must possess a mortgage loan originator license in order to arrange a loan. Although sellers can still hold a loan, they must now follow these guidelines:

– Sellers cannot offer financing on more than three homes per year.

– They can’t extend a loan if they built the property.

– The financing terms cannot include a balloon payment. All loans have to be amortized.

– Lenders must first ascertain whether the borrower is capable of paying back the loan.

– Loans must have a fixed rate for at least five years, with sensible annual increases thereafter, as well as a reasonable lifetime cap.

Why people should avoid creative financing

Even with these preventative measures in place, creative financing carries significant risks for both buyers and sellers. Many of these loans have a very slim margin of error and rely upon the home continuing to gain in value in order to qualify for refinancing down the road. However, homes can and do lose value, which can result in a mortgage that is larger than the value of the property.

The quality of these loans can also be questionable because most lenders lack the experience and knowledge to be experts on credit analysis. For example, they often don’t take into account the borrower’s net worth or character. Further, if a borrower defaults on his or her payments, the seller must initiate collection processes or foreclose on the property – both of which involve a significant time period without any payments from the buyer. This can lead to a dire cash-flow problem for the lender, especially if he or she needs this money to pay down a first mortgage.

Sellers can also experience significant losses if they have to foreclose or sell a low-rate home loan on the secondary market. This could happen for a variety of reasons; for example, sellers might experience a life event that requires them to access the loaned money before the loan term is up. They might also decide to recoup their money to invest in a financial instrument with a higher rate of return.

Creative financing also distorts property values. Houses with attractive financing terms tend to sell for a higher price than properties with traditional financing do. Often, these exorbitant sales prices cancel out any savings achieved through cheaper financing terms.

Speakers Focus on the Importance of Our Founding Documents

The Donald Koch Foundation hosted a presentation by Howard Bay and Clark Beim-Esche at the Principia School in St. Louis, Missouri, on April 4, 2017. During the talk, the speakers discussed the history of the Declaration of Independence and the Bill of Rights and why these documents remain important today.

The speakers both have strong ties to the Principia School, as well as a thorough knowledge of American history. A retired teacher of history and economics at the school, Mr. Bay is also a former Principia student. Mr. Beim-Eshce worked in the English and History departments at the Principia Upper School for more than 30 years. A winner of the Mark Twain Boyhood Home and Museum Creative Teaching Award, Mr. Beim-Esche is also an author. His 2015 book, Calling on the Presidents: Tales Their Houses Tell, is available at Barnes & Noble and Amazon.

Mr. Bay spoke first, describing the Declaration of Independence as America’s birth certificate. He went on to say that “no American document has had a greater global impact” than the Declaration of Independence. In fact, over half of today’s United Nations’ member countries have taken inspiration from our founding documents to create their own declarations of independence. All but two of these documents lack the passage from our document’s preamble, which states that “all men are created equal” and have “certain unalienable rights, including ”life, liberty, and the pursuit of happiness.”

Our Declaration of Independence was a radical document, according to Mr. Bay, because it marked the first time that a government was formed on the basis of a set of “truths.” It also asserted that a government’s power comes from the people and not the other way around. This meant that Americans were now “citizens” and not “subjects.”

Toward the end of his presentation, Mr. Bay described the harrowing journey that the Declaration of Independence and the Constitution took during the Revolutionary War and throughout the decades before ending up encased in glass at the National Archives. The fact that we could have easily lost these valuable documents is frightening. According to President Truman, “Liberty … can be lost, and it will be, if the time ever comes when these documents are regarded not as the supreme expression of our profound belief, but merely as curiosities in glass cases.” Mr. Bay concluded his portion of the talk by warning that in order to preserve the principles of liberty, each new generation of Americans must not only understand the truths expressed in our founding documents, but they must also cherish them.

Mr. Beim-Esche begins his portion of the presentation by comparing the Bill of Rights to the Ten Commandments. According to Mr. Beim-Esche, both documents are basically lists of “thou shalt nots.”

Subsequently, Mr. Beim-Esche detailed the timeline of the drafting of the Constitution, from the Declaration of Independence and the release of Thomas Paine’s Common Sense in 1776 to the Constitutional Convention in 1787. He goes on to describe the addition of the Bill of Rights in 1791.

The 10 amendments contained in this document list 24 limitations on government. Among these are restrictions on laws that diminish the freedom of speech, peaceable assembly, religion, press, and petition. The government also cannot force citizens to house soldiers in their homes without their consent or infringe upon people’s right to have and bear arms.

Additionally, the Bill of Rights prevents the government from conducting unreasonable searches and seizures and requires probable cause before issuing a warrant. The Bill of Rights also guarantees citizens freedom from self-incrimination, double trial for the same crime, arrest without indictment, and loss of property without just compensation. When a citizen is arrested, the government must deliver a just and timely trial, an impartial jury, notice of all charges, and legal representation. The accused also has the right to confront any witnesses. In a civil case over a certain dollar amount, citizens are entitled to a jury trial. Moreover, the government cannot impose excessive bail or fines, or any cruel and unusual punishment.

To further secure against government overreach, the 9th Amendment of the Bill of Rights denies the government any powers that the Constitution does not specifically mention. The 10th Amendment takes this one step further by stating that all rights not delegated to the federal government in the Constitution are reserved to the states and the people.

At the end of his presentation, Mr. Beim-Esche pointed to the bottom of a copy of the Bill of Rights that Donald Koch would later hand out to junior students in the audience. He said, “This copy of the American Bill of Rights is a gift to the students of Principia by the Donald L. Koch Foundation as a timeless reminder that the freedom entrusted to their care is a challenge to their generation—a test of them as individuals to preserve and protect or ignobly to lose.”