Home Buying Creativity Can Bridge Lack of Cash Series: Last of four articles on bridging the affordability gap.

LA Times – Jun 5, 1988 – DAVID W. MYERS

The real estate guru, decked out in a white linen suit and perched on a stage at a swank Hawaiian resort, made it all sound so easy.

With crashing ocean waves and swaying palm trees as a backdrop, Dave Del Dotto, self-proclaimed “cash-flow expert/millionaire,” preached to his audience about buying property with little or nothing down. To his right sat eight of his disciples, from bricklayer to barrister, all of whom told of amassing great wealth after buying their master’s $297-collection of inspirational tapes and books.

Del Dotto and his flock answered questions spoon-fed by Monte Hall, best known as host of the “Let’s Make a Deal” game show popular in the 1960s and ’70s. And the whole spectacle could be seen in millions of American homes-again and again-thanks to several 30-minute blocks of cable TV time Del Dotto purchased to pitch his copyrighted “cash flow system.”

Del Dotto is one of the last of a vanishing breed: The ranks of the real estate preachers have thinned over the past few years as the double-digit inflation needed to make many of their deals work disappeared. A few of the lecturers have even gone bankrupt, victims of bad real estate deals or mismanagement.

But toned-down “creative financing”-or, as some experts prefer to call it, “alternative financing”-still plays a role in today’s real estate market, and it’s a particularly valuable tool for people trying to buy their first home.

“Alternative financing still has its place, but it has to be down to earth,” says Marc Garrison, a real estate investor and author of “Financially Free.”

“If you think you’re going to buy a home with no money down, forget it. But if you think you must have a 20% down payment to buy a house, you’re wrong there, too.”

In fact, some financing techniques that were considered creative when they were first introduced several years ago are now commonplace. At the top of this list is the adjustable-rate mortgage, or ARM.

Adjustable-rate loans first appeared in the 1970s, when interest rates were so high that millions of buyers-particularly first-timers-couldn’t qualify for a mortgage. The first ARMs started out with rates far below those charged on fixed-rate loans, thereby reopening the housing market to many buyers.

Today’s ARMs still offer low introductory rates. But now they’re attractive for a second reason: They’re one of the few ways left that a buyer with less than 20% down can get financing from a bank, because lenders have tightened their credit requirements.

Qualifying Fairly Easy

Generally, buyers who can muster a 10% down payment have little trouble getting an adjustable-rate mortgage. Some lenders require as little as 5% down.

Since most ARMs start out with a below-market interest rate-currently about 8%-qualifying for the loan is fairly easy.

If a couple had a 10% down payment and wanted a $100,000 ARM with a starting rate of 8%, they’d have to earn about $36,814 annually and make monthly payments of $734 for principal and interest. If they insisted on a fixed-rate loan at the current 10.5% rate, they’d have to earn nearly $8,000 a year more and pay an extra $180 a month.

The catch, of course, is that ARM rates are periodically changed. Typically, the rate is adjusted monthly, quarterly or at six-month intervals.

Need Growing Incomes

A mere one-percentage point rise on a $100,000 mortgage that started at 8% would add about $70 to a borrower’s monthly payment. Future increases would push payments even higher.

Gradual increases aren’t a problem for buyers whose incomes are growing as they move up the career ladder. But they can present difficulties-or even trigger foreclosure-if the borrower’s earnings don’t keep up with the rising mortgage payments.

To protect against the perils of rising rates, experts say borrowers should select an ARM that has caps preventing its interest rate from rising more than two percentage points at any adjustment period and five or six points over the life of the loan.

“You could eventually find yourself in a real `cash crunch’ if those limits are any higher,” says San Francisco financial planner John Cahill.

Although an ARM makes it easier for a buyer to obtain a loan, sometimes the amount the bank is willing to lend isn’t enough to close the deal. When this happens, buyers often turn to the seller for help in financing their purchase.

Seller financing usually involves the use of a second mortgage, sometimes called a seller “take-back” or “carry-back.” A seller who takes back a second mortgage essentially acts as a lender, financing part of the transaction.

One Westside couple, for example, recently purchased a $145,000 condominium with a $15,000 down payment. Since they could only qualify for a $110,000 loan from an institutional lender, the seller agreed to take back a $20,000 note for five years.

A take-back helps a buyer in several ways. It makes it easier to obtain a first-mortgage loan from an institutional lender because the first loan doesn’t need to be as large. It also reduces the size of the required down payment and saves the buyer even more up-front cash because sellers typically don’t charge “points”-bankers’ jargon for prepaid interest.

Some Willing Lenders

Finding a seller willing to provide partial financing can be difficult, especially in areas where homes are selling quickly through conventional methods. Some people simply don’t like the idea of being a lender, or need all the cash they can get in order to buy their next home.

Still, certain types of sellers are usually more inclined to provide financing than others. Investor Garrison recommends looking for people who’ve had their property on the market for several months, or owners who are being transferred out of town. “The more desperate they are to sell, the more flexible they’ll be when it comes to negotiating,” he says.

People who own their house free and clear are also good prospects, says Riverside realtor Sandy Sandison.

“If the kids are grown up and the house is paid off, the sellers probably don’t need all their money in one lump sum,” says Sandison, an associate of Betty Landes Realty Services. “And if the couple is retiring to a smaller home, they might like the idea of collecting monthly checks to supplement their retirement income.”

Garrison says reluctant sellers can sometimes be coaxed into providing take-back financing if the buyer agrees to pay an interest rate that’s two or three points above the rate the seller could get from other investments, such as a certificate of deposit or a short-term bond.

As an alternative to seller-financing, some cash-strapped buyers hunt for assumable loans.

When a buyer assumes the seller’s mortgage, he usually puts up cash equal to the amount of the seller’s equity, and then takes over the monthly mortgage payments. For example, a seller who had $10,000 worth of equity in a $120,000 home might be willing to let the buyer assume the loan and take over the payments if the buyer could make a $10,000 down payment.

It’s usually cheaper and easier to assume a loan than it is to get a new one because many of the fees are waived and lenders aren’t quite as finicky about the buyer’s monthly income. Older mortgages often have lower interest rates, and-since the loans were issued some time ago-more of the monthly payment will be applied directly toward the outstanding balance of the loan instead of being “wasted” on interest.

Some lenders won’t allow their loans to be assumed, while others insist on approving any buyer who wants to take over the mortgage. Most fixed-rates loans can’t be assumed, but many adjustables can.

Although the uncertainty of adjustable loans “turns off” some buyers, many of the assumable ARMs issued in previous years are more attractive than their newer counterparts.

Some of these older mortgages started out with extremely low interest rates and have caps that will keep the rate from rising above 11% or 12%-not much higher than today’s fixed-rate loans. Then there are the added benefits of low assumption fees and faster amortization.

Loans insured by the Federal Housing Adminsitration and Veterans Administration are also assumable, and they can offer even better bargains. Their interest rate is fixed, and assumption fees are low.

“And since a lot of homes on the market today were financed with FHA or VA loans within the last few years, it doesn’t take too much money to assume them,” says Riverside realtor Sandison.

Would-be buyers who don’t have much cash or credit can at least start on the road toward home ownership with the help of a lease option.

The lease portion of the contract allows the tenant to move in, while the option gives him the right-but not the obligation-to purchase the property for a specified price at a future date. Most lease options run from one to three years, giving the tenant more time to save up money for a down payment.

Unusually anxious sellers might even be willing to credit a portion of the monthly rental payments toward the tenant’s down payment.

Perhaps the best prospects for lease option deals can be found in the “homes for rent” or “condominiums for rent” advertisements in newspapers. Some landlords advertise that they’ll accept a lease option, while others can be talked into it.

“If you’re lucky, you might even run across a small-time investor who’s just sick and tired of being a landlord,” says Hollis Norton, a real estate investor and author of “The New Real Estate Game.”

“If you rent his place, you’re doing him one favor. If you eventually buy it, you’ll do him another.”

Sellers who are being transferred by their employer are also prime prospects, as are people who are retiring to a smaller home and want to supplement their income with rent checks.

Financially troubled owners may also be willing to sign a lease option, says Garrison, especially if the monthly rent will cover their mortgage payments and stave off foreclosure.

Adjustable-rate mortgages, take-backs, assumables and lease options: They’re just a few of the tools cash-strapped Americans are using to purchase their first home.

New Ways Possible

New ways to buy and finance real estate will undoubtedly be created in the years ahead, especially if home prices keep rising faster than incomes. Some lenders are already test-marketing loans that are easier to get, while a growing number of state and local governments are starting innovative programs aimed at helping people buy their first home.

On the national level, some lawmakers are considering legislation that would allow American workers to put part of their paychecks into a tax-free “housing account” that could be used to save up for a down payment. And a blue-ribbon task force of housing experts is urging Congress to set up “a new housing opportunity program” to build and rehabilitate low-cost housing.

But for now, the task of bridging the affordability gap rests largely on the shoulders of buyers themselves.

“There’s a lot of talk about helping first-time buyers, but right now it’s mostly just talk,” laments David Seiders, chief economist of the National Assn. of Home Builders. “For now, young people who want to buy a house are pretty much on their own.”