Alternative financing when mortgage rates are too high for comfort
When interest rates on mortgage loans climbed to historic levels in the 1980s, it was very hard for the consumer to secure a 16% mortgage loan. Despite these difficult circumstances, the real estate industry employed strategies and tools to keep the market moving.
If a mortgage holder was at Colorado Savings and Loan, the interest rate on a qualifying loan assumption could only be increased by 1%. When interest rates were 16%, a seller might have a loan at 10% and it would only go to 11%! It seemed like such a deal then!
FHA and VA assumptions were a savior of the eighties! Unless the seller wanted replacement of eligibility (in VA cases) or replacement of liability (in FHA cases), a homebuyer could assume the loan with no rate increase and no qualifying! All you had to do was sign your name and come up with the difference between the purchase price and the loan amount. In many cases, the home seller would be willing to carry a second mortgage for that difference. If a seller needed the cash instead of keeping the note, the seller could sell the note at a discount to an industrial bank or private investor. Wow, these were fun times!
The appreciation of real estate values in the seventies actually helped us survive the eighties. Sellers had some equity that they were willing to finance for Buyers at a rate less than the banks had available. Baseline Subdivision houses in Boulder were bringing in about $30,000 in 1979! We thought those were outrageous prices! If the seller had no loan or a large amount of equity, carrying the financing came with an attractive rate of return. At the time they could carry a note and it might be earning 11%! The bottom line, owner financing on flexible terms, helped us sell homes!
As mortgage rates rise, it isn’t quite as easy to come up with alternative financing ideas as in “the olden days”!
However, there are a few alternatives that are still out there.
The first one is FHA and VA Qualifying Assumptions
The homebuyer still needs to be qualified, but the interest rate will remain the same on assumption. If a seller has a 4% FHA loan, a buyer could qualify for the assumption and take over a 4% loan. The challenge today is that home values have appreciated so much that the difference between the home price and the loan amount can be very large. In this case, the buyer could seek out an institutional 2nd mortgage, or potentially ask the seller to finance the second mortgage. In the City of Boulder market, FHA and VA loan limits haven’t been high enough to make those loans commonplace, but in lower-priced areas of the county, an FHA or VA assumption could be a realistic possibility.
The second is owner financing
Home values have risen dramatically since 2012 in Boulder County.
Many home sellers now have strong equity positions compared to the “underwater” days of the recession. Interest rates on savings accounts and very safe investments currently have a low rate of return. These factors can lead sellers to consider that offering financing may be an appealing option for investing their equity. It isn’t as easy today to create an ownerfinancing arrangement as it was in the 1980s. However, more legal structures have been created to make owner financing a practical and realistic opportunity.
Owner financing has evolved over the years. Back in those “olden days” all you needed was a piece of paper and a typewriter to type out a note. Eventually, the Real Estate Commission in Colorado came up with approved note and deed of trust forms that real estate licensees were allowed to fill out. Now, those forms are gone, and all owner-financed transactions need to be handled by an attorney or a Colorado Licensed Loan Originator. Although owner financing rules have become more complex, enlisting the appropriate professionals can help you determine if it is right for you as a seller.
As a seller, you meet with an attorney and/or a Licensed Loan Officer to determine what terms you would like to offer to potential buyers. Once you determine those terms, you can meet with your REALTOR®, to decide how best to market the financing to the marketplace.
The third is choosing a variable-rate loan
A variable-rate loan usually starts at an interest rate that is slightly lower than the current 30-year rate. If you don’t want to miss out on the house you want, using a variable-rate loan can help you get it. The structure of variable-rate loans can vary across the marketplace. If you are going to research what is available, here are a few questions to ask your lending professional:
• What is the initial interest rate?
• What is the index the loan is keyed to and what is the margin added to the index? • How often does the loan adjust?
• Are there interest rate caps and/or floors?
• If rates drop, can I refinance?
• Is there a prepayment penalty?
Once you have an answer to the above questions, your mortgage professional can help you compare the rate to a 30-year fixed-rate mortgage.
The fourth is obtaining a “bought down” loan
Exploring a buydown option is one strategy to ease payments during the initial years of the mortgage. Various forms of this loan are available, from a 1-year buydown, or 2 or 3 years. Buyers can pay for the buydown themselves or negotiate to have the seller contribute to it. In a 3-2-1 buydown, the interest rate starts at 3% off the market rate, then 2% the next year, and 1% the next. At the end of the 3-year period, the rate will be the original market rate for the remaining 27 years. Similar to the variable rate loan above, if interest has gone down, you might be able to refinance into a 30-year fixed loan.
The fifth is what is called an All-in-one Loan offered by CMG Mortgage.
This product is fairly new to the marketplace. It is structured similarly to a Home Equity Line of Credit and is available to purchase 1-to-4unit properties. The interest rate is higher than a 30-year mortgage and is a variable rate. However, it acts like an interest-only loan. That way, you can create a structure that will pay off your loan sooner, saving you thousands of dollars in interest over time, even though the rate is higher.
Rather than missing out on the home you want today, because of interest rates, visit with your Realtor® and mortgage lending professional to develop a plan that works for you.
Duane graduated with a business degree and a major in real estate from the University of Colorado in 1978. He has been a Realtor® in Boulder since that time. He joined RE/MAX of Boulder in 1982 and has facilitated over 2,500 transactions over his career.
Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life. For questions, e-mail duaneduggan@boulderco.com, call 303.441.5611 or visit boulderco.com.
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