Private financing, rate buy-downs can rescue sale

Part 2 of 2: How to close deal when lender says 'no'
By: Bernice Ross: Inman News
(Read Part 1, "Low appraisals kill sales in today's market.")
A slowing real estate market, a credit crunch and an increase in foreclosures means that mortgages may be harder to obtain. What can you do when the lender turns down your qualified borrower?

Last week's article looked at how to handle a situation where the appraisal comes in low on a property. This week we look at additional strategies to assist you in closing a transaction when the lender says "no."

Second and Third Mortgages Bridge the Gap

If the appraisal comes in low and the buyer still wants the property, one option is for the buyer to seek secondary financing. This could involve having the sellers and/or the agents carrying a second or third mortgage. Another alternative is to seek a home equity line from a credit union or business bank. For example, if the buyers planned to make any renovations or to replace major items such as the air conditioning, carpets or appliances after the closing of the transaction, they may be able to obtain a home equity loan for the amount, thus freeing up additional funds to put towards the down payment. A different approach would be to seek financing from a private lender who does "hard money" loans. These loans are typically much more expensive. In a severe crunch, private financing may be your only alternative.

The Buyer Doesn't Qualify

Your buyers may be preapproved for a loan at 6.5 percent and the rates go to 7 percent. If the buyers' original ratios were tight, they may no longer qualify for their loan. This creates an exceedingly difficult situation for all parties. One solution, provided that the seller is desperate enough to do so and has sufficient equity, is for the seller to buy down the buyer's interest rate to the original 6.5 percent.

Many lenders also offer buy-down programs to help borrowers qualify as well. The most common buy-down is known as "2-1." Assume that the rates are at 8 percent. A typical buy-down would be for 6 percent for year 1 and then 7 percent for year 2. At the beginning of the third year through year 30, the rate would go back to 8 percent. At closing, the borrower or the seller prepays the difference in interest for the first two years.

For example, if the borrower is taking a loan of $300,000, the buy-down amount would be two percentage points, or $6,000 the first year and $3,000 the second year, for a total of $9,000. The $9,000 may be added to the purchase price, provided the comparable sales are high enough to support the higher valuation. In the example above where the buy-down is only 0.5 percent, the buy-down amount on a $300,000 mortgage for the first year would be approximately $1,500.

A slightly different approach is to keep the loan fees the same, but to raise the overall interest rate once the buy-down period has passed. For example, if the borrower above was unable to prepay the buy-down amount, the lender could help out with the equivalent of an adjustable-rate mortgage. Assume the interest rate is 7.5 percent with one point. To keep the points at 1, the borrower could qualify at a rate of 6.25 percent. The second year the interest rate would be at 7.25 percent and years 3 through 30 would be at 8.25 percent. There are multiple variations on this theme. The simplest solution may be for the borrower to take a traditional adjustable-rate mortgage rather than working with the buy-down.

No W-2, No Loan

In a credit crunch, lenders tighten the standards for self-employed individuals or people who may be between jobs. Since most self-employed individuals are aggressive in taking business deductions, they may find it particularly difficult to obtain a loan, even if they have 20 percent down and excellent credit. Lenders are nervous that the borrower's business may decline and that the property may come back to them as a foreclosure.

If you're representing someone who is self-employed, expect to have your client's tax returns reviewed as carefully as an IRS audit. Also, many underwriters don't understand the subtleties of corporate or partnership tax returns. The underwriter on our loan disallowed a distribution from our company as income even though we paid taxes on it.

Job history will once again become an important issue as well. One agent was representing a surgeon who was starting a new job at a local hospital. The surgeon wanted to purchase a home prior to beginning his new job. He had several million dollars in liquid assets. Even with "A" credit, the lender turned him down because he couldn't demonstrate two years of income with his new employer.

"The good old days" of 20 percent down, fully documented loans with careful scrutiny of all borrowers are upon us again. Given that there are many more listings than buyers in most places in the country, the tightening of credit may hasten a deeper slowdown. Foreclosures, bankruptcies and overextended borrowers are bad for everyone in our business. In the long term, however, tougher standards will be better for just about everyone.