Articles

ALTERNATIVES

JAMES T. BERGER


Eight years ago, Hector Garcia, a small business owner, had his heart set on buying a $320,000 home with 4 bedrooms, 3 1/2 baths and a 2-car garage on a 2 1/2-acre lot in north suburban Kildeer.

The trouble was, he couldn't get a mortgage. The numbers didn't work, and the interest rates were too high. However, Garcia was able to secure the home through a transaction known as a land contract. Six years later, thanks to his mortgage broker, Edie Jerome of Palatine-based Metro Mortgage, Garcia was able to refinance the home with a conventional bank mortgage.

"I put down a $10,000 down payment, and for six years I made a monthly payment that included interest and equity," Garcia said. "After six years, I had accumulated $30,000 worth of equity in the home, and I was able to get a mortgage from a bank."

The land contract is one of several creative ways a buyer can get a house without a mortgage. Other ways include: rent with option to buy, contract for a deed and whole or partial seller financing.

Jerome says the best candidates for the no-mortgage home purchase option are people who are credit-challenged, people coming out of bankruptcy or foreclosure or people who have had difficulty paying their bills on time.

Buying a home without a mortgage is "one of the best-kept secrets in real estate, and it's not the sort of opportunity that is likely to be advertised," said Richard J. Roll, president and CEO of Stamford, Conn.-based American Homeowners Association (www.ahahome.com). Roll warns that such financing can be dangerous, and the buyer should beware.

With seller financing, the owner of the home functions as the mortgage lender. If the seller owns the home free and clear, he might deed the home to the buyer and become the de facto first mortgage holder. In other cases, the buyer may have qualified for some conventional financing but not enough to swing the deal. Here, the seller may become the second mortgage holder.

Here's how these no-mortgage home purchases work:

The lease with option to buy without down payment or equity is simply a rental in which the erstwhile buyer has the opportunity to purchase the home at some future point and perhaps at some agreed-to price. There are no tax benefits. The seller is only obligated when the buyer achieves the wherewithal to enter into a contract and secure a mortgage.

"This is a bad thing to do," Jerome said. "You have put no money down to secure an interest in the property. All this is doing is giving you first crack at buying the home."

The land contract, such as the one Garcia wrote for his Kildeer home, involves a small down payment and monthly payments that include interest and equity. Such a contract qualifies for mortgage tax relief.

"The goal here is to refinance the land contract into a mortgage," Jerome said. "The reason why a seller might take a land contract is it avoids the perils of renting the home for the owner, because the renter might trash the property and skip town. If the seller has a contract purchaser, they know that purchaser has an interest in the property and will maintain it."

Another form of home purchase without a mortgage is contract for a deed. The buyer contracts with the seller to make payments to a third- party escrow agent who holds the deed to the property. After the length of the contract, the seller informs the escrow agent the terms of contract have been met, and the buyer is given the deed. There never is a bank mortgage.

Another category is seller financing. "Let's say it's a $100,000 house, and the buyer only qualifies for an $80,000 mortgage," Jerome said. "Here, the seller would write a $20,000 second mortgage."

Finally, there is the chance the mortgage is assumable. If it is a Federal Housing Authority or Veterans Administration loan, it might have been written at a time when interest rates were lower than they are currently. By assuming the mortgage, the buyer can cut financing costs while avoiding the need to deal with a new bank or lender.

The buyer who seeks to do this nonconventional financing needs to "carefully do his homework," Roll said. "The key question the buyer has to ask and answer is `why would the seller finance without a mortgage and accept less than a cash payment of the full purchase price?'

"There are two obvious reasons. First, they can't sell it for cash at anywhere near the price they want for it." This can happen during a recession or in a distressed housing market where there is a glut of homes for sale.

"The second reason is the owner doesn't need the cash and doesn't want to get into a pure rental situation," Roll said.

Roll warns of overly slick predatory owners who enter into deals with the expectation buyers will default. "You have to realize the seller has very little to lose in such a deal," he said. "If the buyer can't make the payments, the seller forecloses and keeps the down payment and everything else."

He adds that part of the buyer due-diligence process involves "checking to make sure the seller doesn't routinely do this sort of thing." "In reality, it's a form of reverse flipping, where the owner keeps flipping the house back to himself.

"The buyer must try to protect himself against all the contingencies," he said. "They must put as much cushion as possible into the contract."

While these plans can help a buyer get into a home without a mortgage, Roll cautions consumers to be ultracareful whenever they play in this kind of ballpark. Buyers can't complain to banking regulators if they feel wronged.

"Everything we have ever looked at in this area suggests caution," Roll said. "The buyer absolutely must do his or her homework."

James T. Berger is a Chicago area free-lance writer.

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