Can I tell my sellers it is a good idea to offer seller financing?

By
Real Estate Agent with Century 21 Results Realty

Looking at the legislative landscape, I see a new danger on the horizon.  In addition to the existant dangers of financing a mortgage for a buyer such as their credit-worthiness and ability to repay, there is another risk which could soon be inserted into the pool... 

Cram-Downs

If you aren't already familiar with the term, take a moment to read the definition...  From the perspective of a lender, it is a scary scenario.  In effect, a bankruptcy judge could force down the balance of a loan based on their view of the value of the property. 

Regardless of whether the seller is in the first or second position, they could face financial danger in this situation.  While helping out the buyer and hoping to make a little extra money on the sale of their home, they could find their investment principal... in effect, having the base value of the loan reduced. 

Congress is looking at allowing cram-downs in residential mortgages again.  It is the second time this year that the subject has come up.  Currently they are saying that the new rules would only apply to loans before January, 2009, and that there would be other safe-guards in place to protect the investments of the lenders.  And remember, the lenders aren't actually the banks and mortgage brokers.  The lenders are investors... and that means that they range from school teachers (through their pensions) to corporate portfolios... and anyone else that has money in the MBS (Mortgage Backed Security) market. 

For a look at how cram-down provisions affect mortgages, one only needs to look as far as the commercial mortgage market and compare it to residential.  In effect, rates are higher, down payment requirements are higher, reserve amounts are higher and credit is tighter.  Before the lenders are willing to part with their money, they need to be more sure that they will be paid back, because a judge could reduce the value of their investment if the borrower has a problem. 

And getting a higher interest rate for the increased risk might not help... the same judge could reduce the interest rate prior to lowering the principal balance. 

So, I am telling my sellers that they need to be MUCH more aware of the risks, and that those risks could increase if Congress gets too populist. 

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Rainer
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Ron Parise
LocateHomes.com - Cape Coral, FL

I understand the risk to the lenders as you describe it,  but I dont see that its any greater risk than what  they faced before cram downs. The risk is no different than the risk any investor takes. ie they might lose money.  

After a cram-down the note holder owns a note worth the market value of the property, without a cram down they get the property back, and its worth market value. In either case their asset has been reduced to the market value of the property.

I think the message for folks considering owner financing to facilitate a sale of their property is: dont do it unless you are prepared to foreclose, or take a loss on the note.

Apr 25, 2009 01:04 AM #1
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Lane Bailey
Century 21 Results Realty - Suwanee, GA
Realtor & Car Guy

Ron - There is a major difference.  Under the current system, the lender determines if they want to write down the balance of the mortgage, and if they foreclose, the market determines the value. 

Under the proposed cram-down legislation, a bankruptcy judge would be the one making the determination of market value.  They are free to use their judgement to determine the new balance of the mortgage, and it would not be illegal or against the rules for the bankruptcy judge to write down the mortgage drastically or even completely... regardless of the market value. 

It is my understanding that in commercial real estate, there are times when the mortgage balance is written down to a point where the bankrupt company can afford the property... even if there might have been another buyer willing to pay more.  If the judge determines that the company can afford $X, he can determine that that is the market value. 

There is MUCH great er risk when there is a person making the judgement rather than the market at large.

Apr 25, 2009 08:32 PM #2
Rainmaker
573,927
Terry & Bonnie Westbrook
Westbrook Realty Broker-Owner - Grand Rapids, MI
Westbrook Realty - Grand Rapids Forest Hills MI Re

I never thought it might affect sellers that loaned money to buyer. Thanks for the info.

Apr 25, 2009 10:12 PM #3
Rainer
86,440
Ron Parise
LocateHomes.com - Cape Coral, FL

Lane

I disagree. The risk is the same... Under the current system the lender gets the property back. and its worth exactly market value....Under the proposed system the lender would still own a mortgage, but it would now be worth market value. The risk is the same...The asset could shrink to market value. ie If you make a loan there is always the risk that your asset could go down with the market. and thats true with or without cram downs There will always be the question of what is market value?...but thats a matter for another post.

By the way  bankruptcy judges can already cram down loans that can be paid off within the time frame of the bankruptcy payment plan (no more than 5 years) This happens to the folks that make car loans all the time. The only reason that they cant cram down mortgages loans is because they extend as long as 30 years and most folks in bankruptcy cant accelerate their mortgage payments to pay them off within 5 years.....Also did you know that 2nd mortgages can be wiped out altogether in bankruptcy. Thats not a proposed rule, thats current practice. If the market value of the property drops to the point where the 2nd is no longer securred, it can be treated as an unsecurred loan in bankruptcty and discharged just like a credit card debt.

The problem is that most of us have trouble wrapping our minds around the concept of risk in real estate. Even in these times, we want to stick to the assumption that real estate always goes up in value. Thats not true. We need to accept the fact that anyone that owns real estate or owns debt securred by real estate may lose money....ie real estate is a risky investment.  And if your client wants to play with the big boys (the banks) and make mortgage loans where the risk is so great that the banks wont make them, in order to sell his property, then he must know that he is entering into a risky investment. The proposed bankruptcy rules dont change that.

Apr 26, 2009 09:55 AM #4
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Lane Bailey
Century 21 Results Realty - Suwanee, GA
Realtor & Car Guy

Terry - You are welcome. 

Ron - Big difference between the market deciding the value and a judge deciding the value.  that is the danger.  There is a better chance that the value will be decided wrongly by a judge than by the market... market value by definition is decided by the market.

Apr 26, 2009 11:20 PM #5
Rainer
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Ron Parise
LocateHomes.com - Cape Coral, FL

Lane, there is no question that there is a difference. Id bet that the judge will rely on expert opinion, probably an appraiser or two (one from each side) Its just as likely that the judge will decide that the borrower cant even afford the reduced mortgage and order it returned to the lender.

It looks like we come out of this agreeing that if you plan on becoming a mortgage lender, plan on accepting some market risk

Apr 26, 2009 11:54 PM #6
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Lane Bailey
Century 21 Results Realty - Suwanee, GA
Realtor & Car Guy

Ron - There is risk regardless of what happens.  I just trust the market to find market value more than I trust a judge.  At least (for a private loan) if the property is returned to the lender, they can determine IF they want to sell it or if they might prefer to rent the property out.  If a judge just writes down the mortgage, the lender doesn't have that choice. 

Apr 27, 2009 11:48 PM #7
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