New Mexico Real Estate Contracts
I wrote this article when 30 year fixed rates were around 5.5% - to prepare my customers for a real estate reality soon to come. In this slow "Buyers' Market" many would-be Buyers are finding it hard to qualify for a loan even though their monthly payments on a mortgage might actually be lower than their present monthly rent. A Real Estate Contract can be great way for a Seller to get his/her house sold in a difficult market while also helping that would-be Buyer.
[The examples below are for illustration purposes only and do not reflect today's exceptionally low rates.]
Do you remember those days of run-away inflation when Jimmy Carter was in the White House? Mortgage rates were SO high that few people thought they could afford to buy a home! In fact, often real estate transactions only occurred where there was a Seller willing to offer Seller Financing.
Here in New Mexico, we have developed an affinity for the Real Estate Contract (REC). In those days, Sellers were able to offer an REC with rates below the 19+% rates appearing on the open market. Why?: Because, if they had purchased their house at say 12%, they were only too happy to finance their Buyer at 18% and draw income on the difference.
In similar vein, if mortgage interest rates begin to pick up again after the election, as many predict, the REC may begin to look like an increasingly popular option.
An Example:
Say that "Tomorrow’s Seller" has purchased or refinanced his/her home recently at 5.5%. Say rates are back up to 8% in 5 years, at a time when he/she is thinking of selling up and moving on.
"Tomorrow’s Seller"sensibly considers selling his/her home under a REC:
- to make his/her house more affordable and therefore more DESIRABLE to Buyers in the market place &
- to generate a small income stream for him/herself.
Here is a financial overview of his/her situation:
Purchase Price in 2004: $200K;
Finance Rate: 5.5%;
Loan Term: 30yrs; 5%
Down-payment: $10K;
Loan Amount: $190K;
Monthly Mortgage Payment: $1079
Principal Balance on Loan after 5 years of Payments (assuming no extra payments have been made): $175,675
So, in 2009 "Tomorrow’s Seller" has $24,325 invested in the house ($200,000 purchase price - $175,675 outstanding loan balance)
To be conservative, let’s say that between 2004 and "Tomorrow’s Market" (in 2009) property prices have appreciated by just half the 4% average annual rate that has prevailed here in the Greater Albuquerque Metropolitan Region for the last 20 years. [Interest rates, not prices, are the KEY factor in this scenario. The logic is the same whether prices are higher or lower.]
"Tomorrow’s Seller" could sell to a Buyer with mortgage financing:
Hypothetical prevailing interest rates in 2009: 8%;
Anticipated Sales Price (2% compounded over 5 years): $220.8K;
Buyer with mortgage financing makes down-payment of 10%: $22,080;
Buyer’s hypothetical loan amount $197.2K;
Buyer’s hypothetical 1% Loan Origination Fee: $1,972;
Buyer’s 10% Down-payment plus Loan Origination: $24,052
Buyer’s Monthly Payments with 8% financing: $1447
Instead of the Above: "Tomorrow’s Seller" offers REC financing at : 7.25%
Seller sells to Buyer at: $225K instead of $220.8K;
Buyer's Down-payment (to Seller) of 10%: $22,500;
Buyer has NO Loan Origination Fee (Seller is financing);
REC loan amount: $202,500 ($225,000-$22,500)
Buyer’s Monthly Payment to Seller at 7.25% = $1381
Buyer is Happy to pay Seller $225K under the REC because:
1. Even though Buyer’s 10% down-payment is greater at the higher sales price ($420 greater), he pays no loan origination fee [$1,972] and so saves a net $1,552 in immediate out-of-pocket expenses.
In the Buyer’s mind, saving this $1,552 reduces the effective sales price from $225,000 to $223,948 [$225K-$1,552] – just $3148 more than the sales price were he to obtain his own mortgage financing.
2. As the Buyer is being financed at 7.25%, his monthly payments are $66 lower than they would be at the lower price of $220,800 with an 8% rate: giving him an annual savings of $792!
3. So, the Buyer anticipates recouping the $3,148 effective higher sales price in just under 4 years (48 months at $792 savings per month).
[And I haven't even mentioned the monthly mortgage insurance premium payments that the Buyer would have had to pay if he had obtained 90% financing from a mortgage lender].
Meanwhile, Buyer has a more affordable loan package on a Real Estate investment that he anticipates will appreciate in value during that time-period.
"Tomorrow’s Seller" is happy to Sell under a Real Estate Contract because:
1. The Sale Price is $4,200 higher.
2. He/She continues to make monthly mortgage payments of $1079 on his/her original 2004 5.5% loan. However, Seller receives $1381 per month from Buyer: providing a net income of $302 per month or $3,624 per year. Considering "Tomorrow’s Seller" has just $24,325 invested in the house ($200K purchase price, less $175,675 outstanding loan balance), this is a decent 15% annual return on his/her investment.
Both Buyer & Seller are happy!
Please, do contact me if you have any further questions about the REC
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