HOW TO BUY A HOUSE WITH BAD CREDIT
Why is a typical mortgage 30 years? Residential housing has been subsidized for 100 years. It’s the reason people usually have to get a mortgage in order to buy a house. It’s been subsidized mostly with debt. If you ask most people in Europe and Asia, they own their homes without a mortgage. The thinking in most European and Asian cultures is that taking on long term debt to buy a house is perverse, or just plain stupid. I’ll tell you why a typical mortgage in the western world is 30 years, and it’s for one reason only, so that the banking system can use the 30 year obligations as assets and acquire pension funds, insurance cash flows and other liquidity. If we stop subsidizing residential housing, the prices will fall to a level that actually serves the people using the homes instead of enslaving them to the corporations that do not use the homes. This has to be a cultural change, just like our culture of saving and building or buying homes with cash and short term debt was changed to long term debt and zero cash deals. Wouldn’t a 7 year mortgage serve people better? I’m only asking this rhetorically because I want to get you thinking that it’s possible and even necessary. But for the purposes of this article, let’s just discuss how we can buy a house with bad credit. Let’s start with a premise that many people haven’t heard or don’t believe. It’s easier to buy a house with bad credit than get a two-year mobile phone contract or unsecured credit card. And one more, your first choice for lenders should be the seller. This is not necessarily true in a “fast market”, such as where homes are selling within 7 days, or even 90 days; however, the deals are still there. It’s just easier to buy a home where the market is slow… slower or slowish. You can easily determine how fast houses in your market are selling by asking a real estate agent or checking some of the real estate databases online, or just looking around the neighborhood. Lease with an Option to Purchase The most popular method of buying a house without traditional bank financing is the “lease/option”. My wife first objected to leasing because of the lost opportunity to accrue money in equity, but a lease contract can be written to preserve equity. For example, your lease can include an option to purchase the property. You can either pay for the option, or try to get the owner to give you an option to purchase at some point in the future, that depends on the market and sophistication of the owner/seller. The options contract appended to the lease agreement can include a provision stating that lease payments must be credited to the purchase price if you exercise the option to buy. The option can be exercised when certain criteria are met, such as by a certain date, or when the fair market price of the property reaches a certain level. The option state that the price is fixed or that the exercise of the option is based upon the fair market price at the time the option is exercised. You can make your lease/option agreement into a real owner financing deal by adding a provision in the option to purchase that the lessee has the “first right of refusal”. This means that if the owner wants to sell to someone else during the term of your lease/option, the offer must be made to you first and you have to be given the option of accepted or rejecting it before the owner. If you reject it, then the owner can consider the offer to sell. If you exercise the option to buy, the seller can hold the note, and in some cases, the deal might involve you finding a buyer for the note. This is typically what happens when you exercise a lease/option contract, but it’s not necessary. If you make a deal with the seller to finance the sale of his home, he will carry the note or allow you to make payments under the terms of a mortgage. You can do this at the beginning if you want, or you can work into this type of deal from a lease agreement. Some sellers want to carry a note, and there are some investors that want to buy these notes. This leads to another strategy that may help you close a deal. If you know how to find a buyer for the note, you can make this part of the deal with a homeowner who might not otherwise be willing to sell on owner financing terms. If he knows that it is likely he can sell the note and get his case now (at a discount rate of course), he might be more willing to finance the sale of his property to you. Subject To Most mortgages today are not assignable; however, there are ways to buy a home subject to the terms of the existing mortgage. When a property owner sells his home "subject to" the existing mortgage, the buyer must make the payments on the mortgage or lose the property by foreclosure. (That is the same as if the seller were not making payments on his loan.) However, the foreclosure will never show up on the buyer's credit record because the buyer was not legally obligated to make the mortgage payments on that existing loan. Such a foreclosure on a "subject to" mortgage will adversely affect to seller's credit record, not the buyer's. When you make a contract to buy a home subject to the terms of the existing mortgage, you reduce that contract to writing. That becomes an additional contract to purchase the title and possession beyond the mortgage. The mortgage lender is not concerned with the owner of a home making any contracts for the title of his property, provided that he doesn’t transfer the title as it may invoke the “due on sale clause” in the mortgage. A “due on sale clause” allows the banks or lender to foreclose if any changes to the title are made while the mortgage is pending because those changes might adversely affect the interests of the lender and investors.
Cash is King, but Not Always Cash will help you more than not when buying a home. You will go very far with 10%, 20% or even 50% of the purchase price of the home if you can offer that as a down payment. You might be shocked at the idea of a 50% down payment for a home, but this is how people bought homes before the government reorganization of 1933. In addition, mortgages were no more than 5 years. The first home I bought was with a 15% down payment and a one year mortgage, which I paid in 3 months. I then sold the home and carried the note for the buyer, and then sold that note a couple of years later once the buyer restored his credit. I didn’t get rich, I only broke even, but I did manage to get rid of an “alligator” as they say (it was costing me money) and give me some liquidity that I used to make money. I didn’t use a second mortgage here, but you could use a second mortgage where the seller holds the note as a down payment, or some factor in the financing. For example, let’s say you want to buy a $250,000 home, and you only have $10,000 cash to put down. First I’ll caution you to review the deal and consider finding something that costs less if you only have $10K, but for purposes of this article, you want to make the deal. You need another $15,000 for the down payment, it’s possible that you can offer $275,000 on the home on the condition that the seller will carryback a second position note for $115,000 (not just the 15K). Your first position lender will see that your down payment was $10K in cash, $15 in seller financing and that the seller is also financing another $100,000. This leaves only $275,000 minus $10,000 minus $115,000, or $150,000 needed for financing. The only restriction on this is that the price offered should be very close to the fair market value in order to get first position financing. Seller “carryback” financing is basically when a seller acts as the bank or lender and carries a second mortgage on the subject property, which the buyer pays down each month. Not only is it offered as a means to getting the home sold, but often it’s necessary to get the deal done if conventional banks and lenders won’t offer the total amount of financing needed. By offering seller carryback financing more buyers will be able to qualify to buy your home. It also makes your home more attractive to buyers, and can boost the sales price of your home as well. In addition to that, you’ll be earning interest each month as opposed to a straight cash sale. The idea behind it is that if you believe in the value of your home and feel the buyer will make the mortgage payments without fail, it can be a good investment and a means to facilitate the sale of your home. In tough times, it may be the deciding factor on whether or not you sell your home as sellers shop around for the best terms.
This type of transaction usually occurs because there are not enough prospective buyers who can qualify for conventional financing. If there were, there would be no need for the seller to take back a note. Even when the buyer can qualify for a loan, the buyer may not have enough for the entire down payment. In this case, the buyer gets a first loan from a lender who wants to be the first lien holder (usually a bank or sophisticated investor), and the seller takes back a second note and secures his interests with a mortgage or deed of trust. Because the buyer is able to buy a property that he or she would not otherwise have been able to buy, and because the value of the $100,000 face value note in the secondary mortgage money market is only about $70,000, assuming yields in that market are 15% at the time of this sale, the buyer may be willing to pay more than the current appraised market value of the property. This is true because with a seller carry back note the buyer doesn’t have to pay points, fees and other costs usually associated with an institutional loan. The seller carry back note can be structured in an almost limitless variety of ways. The note can be fully amortized with no balloon payment, amortized over a number of years, say 30 years, with a balloon payment at say 10 or 12 years. The note could be interest only with a balloon. It can even have stepped interest payments (for example, 8% in year 1, 9% in year 2 and 10% in year 3 through the end of the term), or graduated payments (for example, $500 per month for the first 12 months, $600 per month in year 2, $700 in year 3, etc.) The value of the note in the secondary mortgage money market depends on all of these parameters and more. The value of the note that is held by the seller is very important because the seller may want to sell his note. Investors may buy the note and the price they offer is based upon the terms of the note and the borrower’s credit of course, but more importantly, on the terms. The seller will sell the note for less than the face value because the cash he gets is worth more to him today than waiting so many months or years, and the buyer is willing to pay the discounted price because the note would fit perfectly into his investment portfolio.
Peer to Peer Lending Also referred to as marketplace lending (or MPL), peer-to-peer (or P2P) lending is a relatively new form of debt financing. It enables a person to take a loan or invest in lending money without interacting with the establishment banking financial institutions. By running P2P lending services via online websites and integrating simple interface lending platforms, it has quickly become the easiest and quickest way to find a loan or lend. Additionally, P2P lending platforms often offer a higher rate of return for investments than that of financial institutions, providing a source of fixed income for services investors.
Following the financial recession of 2008, peer-to-peer lending companies became increasingly popular for borrowing and lending money. Banks were refusing to increase their loan portfolios; therefore, leaving common people and small businesses with little choice, but to seek resources elsewhere. Through P2P lending companies, another way was forged for common people and small businesses to find a credit lender.
Compared to stock market investments, P2P investing has grown as a substantial source of fixed income for many investors. It inherently is less tumultuous than the stock market and less volatile. The return rates on investments are also significantly higher and more stable than investments made on the stock market.
Through the accessibility to big user data, P2P lending platforms have grown in size and competition since their inception. Credit risks can be assessed more conclusively than by using a FICO score solely, which allows for credit to be granted within as little as five days from submitting an application.
Most peer-to-peer loans are unsecured personal loans with most of the largest loan amounts being granted to businesses. However, if a borrower has collateral, such as luxury goods, jewelry, automobiles, art, real estate, or other business assets this can be used to obtain a secured loan. Peer-to-peer loans are not limited to personal loans, however. They can also include, student loans, commercial real estate loans, payday advance loans, and secured business loans. With a P2P loan, borrowers are taking a loan from an average Joe, through the intermediary business of a P2P lender. A personal loan can be obtained in limits as low as $1,000 and many personal loans cannot exceed $35,000. For a small business, loans may be obtained in amounts beginning around $15,000 and reach limits of around $100,000.
Many personal and business loans granted by a P2P lending service provider are taken out for the purpose of refinancing an existing loan in order to pay off credit cards or for home improvement projects.
If you are a borrower with excellent credit already, an interest rate as low as 7% may be obtained from a peer-to-peer lender. The low-interest rate of many P2P loans is the biggest draw for many borrowers. Lending Club, the largest online peer-to-peer lender on the market, holds an average interest rate of about 14%. The national average in the United States is around 13% and Lending Club comes in just above that rate.
For individuals with good credit scores, a P2P loan is arguably the better way to go. However, for those classified as a risky borrower, they will carry a higher risk of defaulting and, therefore, a higher interest rate on their P2P loan.
The rates for high-risk borrowers will likely remain closer to that of a financial institution's loan interest rate scale for a typical credit card. The highest percentage of interest, which any peer-to-peer lending service will designate, is upwards of 36%. However, Lending Club’s highest interest rate goes to, about, 25%.
Typically, peer-to-peer loans will be issued to the borrower with a three- to five-year loan repayment plan. Payments are due monthly and borrowers are made aware of the exact timescale in which they will have their P2P loan paid off.
A term-based loan, which carries a plan for paying it off, is sometimes considered more favorable to a borrower, which is a major benefit of borrowing from a peer-to-peer lender. Knowing that a loan will be repaid within a five-year period, allows individuals and small business owners to plan for the future with confidence.
Lenders Want You to Buy Assets I’m restating this from my article on How to Buy Cars with Bad Credit. This may sound like a long term project, but it’s really the best practice when buying a liability such as a house (unless it’s for investment purposes). I’ve spoken with prospective clients before and asked if they had any assets and quickly discovered that they believed their homes and cars were assets. It is true that cars and homes are assets but they are not the owners’ assets. These are the assets of lenders, auto-repair shops, contractors, and insurance companies. Make no mistake that a car is a big fat liability. Once you know that a lender is more likely to lend to a borrower who is buying an asset, why don’t you consider buying an asset for a balance sheet, and then use that at a later date to buy a liability, such as the house you want. You may have to read this last sentence several times. People don’t normally talk this way, especially people who aren’t rich. The way people get rich is that they do not use their employment income and personal credit to buy liabilities, they know that this practice keeps you poor. They use a business to acquire assets and credit and tax breaks, and then use that business to buy liabilities. Boy, that sounds like a lot of work just to buy a house right? Well, maybe you’re at a age where it’s time to adopt better habits. It is very possible to establish a new cash flow from a business or even from a property right within a period of about 18 to 60 months. Here are two examples. Research online a popular topic. Write a 60 page book about it with your research, have it edited for about $150 and published through a turn-key self publisher on Lulu or Amazon. You could even have it on the shelves at Barnes n Noble within 6 months. If it has a snappy title and catches one, you could make a few thousand dollars, or maybe a few thousand dollars a months for a few years, maybe more. If it’s really successful, you could franchise it and create a series, such as the books series “for Dummies”.
Once you create your cash flow, you can then produce a balance sheet and income statement separately from your personal credit score and use that to obtain financing for many things. You could get financing to expand your balance sheet with a new idea or buy a personal liability, or a liability for the business that you can use personally. At the same time, we know that many of the quality cryptographic currencies are increasing in price against the dollar, especially Bitcoin. It makes sense to save some of your cash into Bitcoin or Litecoin while you’re waiting for that day when you can buy a car on credit with 50% down for example. Another example of assets you can easily buy while building your balance sheet are tax lien certificates. This is an investment in the same industry where you want to buy a house (real estate, same industry). Sometimes people cannot pay their property taxes, for example, in your state. Your state taxation department may sell the resulting tax lien for a discount at auction, giving the buyer the cash flow and right to foreclose unless it’s paid with guaranteed interest and penalties. About half of the states sell tax lien certificates and half sell tax deeds. You can buy these one by one, or entire portfolios at a time. You should understand what’s required in managing this type of asset, but it’s something you can easily do with a little effort, maybe a few hours a week. You can buy a tax lien certificate for $50 or $1,500 that might be worth three times what you paid. You list that as an asset on your balance sheet along with payments you may have received as income from the asset, and abracadabra, you have something to show creditors. This asset is scalable, unlike income from a job, you can only work 168 hours in a week, assuming that would even be legal, it’s not likely. But owning assets such as guaranteed cash flows from real estate tax liens and deeds is how people get rich, but it’s how you can get what you want from credit without being victimized by a score. One more point, when you buy assets to offset the cost of a liability, once the liability is paid, or at least the debt service is paid, and you have asset income paying for the costs of having the liability, you still have the assets, even after you sell the liability. You will still want to improve your credit score, especially to get better insurance rates; unless of course, you have your own risk pool and understand how to organize a company to carry your own car insurance (technically, it’s “financial responsibility” in this case and not “insurance”). Go Big If you’re going into long term debt, go big. A house is going to be your liability, probably the biggest liability you will have. If you are going to invest that much money into a liability, why not go big and buy a multi-family complex as a business. You can either live in one of the units, at least for a short time, and use the rental income from the other units (your neighbors) to off-set your liability. If that works, do it again until you have a positive cash flow. This strategy will continue to pay you more over time and you will qualify for lenders who specialize in lending to businesses such as people investing in real estate, known as “non-conforming” lenders.
Crowd Funding for Mortgages It’s now possible to invest in real estate through crowdfunding platforms or even raise enough money to cover the purchase of a home.
The other crowdfunding flavor on the real estate front features mortgages. Think of the friend who can’t get a Fannie Mae loan and instead opts to go online to get a mortgage to buy their home.
That’s right: Multiple people can invest in a person’s mortgage. And your investment can be spread across multiple mortgages, providing diversity within this investment class. These borrowers may be seeking a crowdfunding solution because they cannot get a traditional loan, a real challenge for many consumers today, even those with decent credit, and one that’s led to the growth of peer-lending sites like Prosper and LendingClub.
Privlo, expected to launch soon, reports that is has already funded $28 million in loans to those who hold non-traditional jobs and therefore have a hard time meeting traditional credit standards. LendInvest, based in the U.K., also offers a peer-to-peer lending network focused on residential and commercial mortgages.
Sure, disintermediation is occurring in many areas thanks to the Internet. The difference, however, is that these platforms aren’t featuring products for sale, but, rather, people’s money and ability to repay. The novelty, coupled with the risk to average investors (think Bernie Madhoff online), really demand protections for consumers.
Real estate, real due diligence
If you’re thinking of venturing into the real estate crowdfunding world, there’s a lot to keep in mind. This is new territory (no pun intended) with lots of unknowns.
Like any kind of crowdfunded project with many small owners, if the firm or platform behind it fails, the investor has a mess to sort out to track his investment.
“There’s so much to know, like who’s the general partner of the properties,” says Deena Katz, CFP, of financial planning firm Evensky Katz and an associate professor of financial planning at Texas Tech.
Just as when you purchase a REIT or any other investment and put your faith with the manager, you’re placing your trust into the vetting process and expertise of the people who select the properties placed onto the platform. Do they have the expertise? What’s their process? How can you believe that what they say is true — from the backgrounds of the leaders to the facts about an investment? And if location really does matter in real-estate investing, that can be tough to gauge online.
Indeed, the average investor may have excess cash to invest, but that doesn’t mean he or she has the sophistication to monitor these properties and understand aspects ranging from the financial statements, default rates, and tax implications to developer compensation models and how to unload the property if needed.
The Internet is transforming investing. For regulators, it’s an opportunity to better protect consumers and ensure true transparency: collect comments and data online that could even speed up the capture of the next Bernie Madhoff.
For investors, it may be a way to further diversify your portfolio. But be sure you do your homework and remember one of Peter Lynch’s golden rules of investing: “You have to know what you own, and why you own it.”
Have Confidence Believe that you can buy a house without using traditional lending. People will sometimes reject you, even to have a conversation if it appears that you want a deal with “creative financing”. Remember, this is a numbers game, there is another deal down the street. Instead of looking at 2 or 6 houses to get the one you want, you might need to look at 20 or 40 deals, but it’s worth the time in my opinion.