Use Options To Minimize Risk And Maximize Profits
|I received an ad call one afternoon. It was a woman named Leanne. She was married with three grown children. She wanted to sell their house, so I went through the process of screening the call and getting the relevant information about the house, the mortgage balances, and what they wanted. It was a nice house, 3/1, 1300 sf, basement, on 2.5 acres, no repairs needed, just outside a town called Spencer, Indiana. They had two mortgages totaling $64,000 and were $4,000 behind in payments. The property was appraised one year ago for $97,500. We talked for a while and she informed me that since they had gotten a 2nd mortgage, she and her husband Greg were having difficulty staying current on the payments, and Greg hasn't had much work recently so now they are really behind and have to do something. Leanne asked me what I would pay them for the house. I asked her what she was looking for. I believe the conversation went like this:|
"Well, if we could sell the house and get $85,000 for it we'd go ahead and do that."
I said, "$85,000. For a cash sale, Leanne, that's a bit higher than I can go. If I did pay you cash and paid off your two loans, are you sure you couldn't go any lower than that?"
"How much lower?"
I told her, "Well, based on what you've told me all I can really do here is save your credit by paying off your underlying loans and back payments. I might be able to go a couple of thousand higher but that would be about it."
"So how much is that?"
"Now this is based on your information now. You said that you had $64,000 owing and were $4,000 behind in payments. If I paid those off and added on a couple of thousand for moving money then that would make it around $70,000."
"Is that what you would pay? $70,000?" she asked.
"That's right Leanne. $70,000 is what I could pay."
Long pause.............. longer pause..................and then a big, long, sigh from Leanne.
"Well how long would this take?" she asked, breaking her silence.
I said, "Well, the way I would have to do this Leanne, is to option your house. You see $70,000 is more than I'd be willing to come out of my pocket with to buy the house, but I would be able to finance it for that much. It would take about three weeks before I get things organized on my end to exercise my option and then another three weeks before we close."
"Six weeks, huh?"
"Yeah. Does that sound like it's going to work for you Leanne?" I asked.
"Well, it could be OK. I don't know. We were really looking for more but let me talk to my husband, Greg, and we'll talk it over. I'll tell him what you said and we'll get back with you tomorrow."
"OK Leanne. When do you think you'd be calling?"
"Oh, probably in the afternoon. Talk at you later."
And we ended the call. I thought the deal sounded good, but I didn't know what the husband was like and anticipated he would come back with all sorts of objections about the option. What was it? How are we protected? Why can't you pay more? Rather than worry about it I reviewed the answers to all of those questions and then set about finishing what I was doing before the call.
The next day at about 2:30 pm the phone rang. It was Leanne. She told me she had spoken to her husband about it and they had decided to go ahead with the $70,000 Option deal I had proposed to her yesterday. They wanted me to come out and explain it to them a bit more and get the paperwork signed. I made an appointment for the next day at 5:00 pm.
The following day, I showed up at their house in Spencer and after some small talk began to tell them about the option contract and what it meant, that it gave me the right to buy but not the obligation to, and that they also had the right to continue trying to sell the house on their own if they wanted to do that, that clause is written in the agreement. I explained to them how I was going to sell the house with owner financing and then sell the note for cash to pay them off.
They agreed with me that it should be easy to sell on a Contract, but they wanted to know how long it would take me. They then informed me that the house had been listed for nine months and hadn't sold. I didn't know that. Well, I couldn't be sure, but I expect it would take about three weeks to find my buyer. I would need a three month option, but it should only take about three weeks to find the buyer. I then went into an explanation of how I would market the house, how I qualify all my buyers first and then only call them for a walk-through when that's the only thing left to do. No pesky appointments.
All of this, including a bit of tangential chatter, took about three hours. But at the end of it all, Leanne and Greg signed the agreements and seemed to be comfortable with me and my plan. They asked one last time if I could pay them a bit more than $70,000. I explained that this was the most that I knew I could deliver to them. I could agree to pay them more but if I did that I would be dealing with unknowns and it could cause problems later if I wasn't able to deliver their price. So rather than get their hopes up with a higher price, I would prefer to stick with the promises I know I can deliver on. They seemed happy with the explanation.
So I drove home with the signed Option Agreement, pretty happy. The next day I ran the following ad:
Spencer - Contract. Owner
Will Finance Gorgeous 3br 2 ba
home on 2.5 ac. $105,000. $900/mo
+ Down Pmt. Call 333-4455
I set up a voice mail box to pick up the calls. The greeting repeated all of the information in the ad as well as the address and told the caller to drive by the property and, if interested, to call back and leave a message with their name and phone number.
After two days I began getting calls. Most people wanted to know how much down was needed. For each of these my response was "how much do you have?" They would say something like a thousand dollars and then they would say they couldn't afford that high a payment and they had credit problems and they didn't like the area. After two weeks, I'd spoken to about 30 junk callers like this, but also had about five people with good enough income and credit and varying amounts of acceptable down payment (5%+). After three weeks of screening calls I found a lady who said, "Hey that's a nice house. I want it." Her name was Candy and her husband was Charles.
I took an application over the phone and prepared to pull her credit. Candy and Charles made a combined income of $6,000 per month, easily covering their debts. I asked her how much she had to put down, and she said none. She didn't have anything to put down. I told her I needed something to show their commitment to buying the house, and with her income she should have had something saved, what was going on? She went on to tell me how they had just been through a very long and drawn out child custody battle with Charles' former wife, had won the custody of the two kids but had been cleaned out by the attorney fees. I told them I needed some sort of down payment, even if it was just symbolic. She said she had none. They had a good income but no cash right now, that's it. I asked what her credit was like and she said perfect. So I told Candy that I would give her information to the note investor who would be buying the mortgage to pull her credit and review her information. If the investor sees a high credit score on the report and OKs buying the note with no down then we could do the deal. It would take a day or so but I would get back with her when I got word. She sounded even excited when she said, "OK, call me as soon as you know."
Before I called the note buyer, I drew up the deal on a piece of paper so I had some hard numbers to work with. I decided the purchase price would be $105,000 so this would be the new value. A year earlier the house had appraised for $97,500. Allowing for appreciation, $105,000 was on the high side but reasonable. It was a nice property. I knew this particular notebuyer went up to 82% ITV (Investment To Value) with their note purchases, and that their minimum discount was two percent. This was a solid borrower so I figured 3% to be on the safe side. What I was trying to do was find out what would be the note amount that when discounted two percent would leave me with the 82% ITV maximum that the notebuyer would pay. Well, 82% of $105,000 is $86,100. And if I divide $86,100 by .97 I get $88,762.89. I decided to make it $88,500 to stay with round numbers
So my deal was: 1st Mtg: $88,500 at 9.9% for 30 years, fully amortized 2nd Mtg: $14,500 at 10% for 15 years, fully amortized 3rd Mtg: $ 2,000 Down payment ($200 per month for 10 months).
I filled out a Paper Worksheet with all the relevant details about the transaction and faxed it along with the 1003 Standard Loan Application I had filled out for Candy and Charlie to the notebuyer, with a note saying that it was the 1st Mortgage that I wanted to sell. She called me back the next day with her quote. It was 97.5%. They would purchase the note for 97.5% of the face amount. Boy! That was even better than I had expected. No problem with the lack of down payment, the borrowers had good credit. 97.5% of $88,500 was $86,287.50. My immediate thoughts were that I would be clearing about $15,000 cash at closing, after closing costs. Gee. Gee Whiz! That's a nice profit.
With the quote in hand I called Candy to give her the good news and made an appointment for her and Charlie to see the inside of the house the next day. I was cautious about being too optimistic as no money had changed hands and they hadn't signed a contract yet. Meeting them at the house, I showed them through pointing out all the good things and telling them what I knew about the house. We moved on to the yard showing them the property lines and eventually got back to my truck.
I asked them, "Well, what do you think?"
I wasn't sure, but I think I made some sales mistake by asking them that. At any rate, this question seemed to bring to light the fact that Candy was having a bit of trouble taking the step and committing to the deal. Charlie was saying it looked fine let's sign, but Candy was umming and ahh-ing and looking very uncomfortable, looking around, and giving these furtive looks to Charlie as if to say, "save me." She started to say "well I don't know" kinds of things and then asked if they could think about it. I hated to break the easy-going mood that had existed up until now but the time had come for us to get a little more serious. About this, I knew there were some sales rules to follow.
I told them, "Well, maybe on another house you could, but on this one I'm going to have to know what you want to do today. Because I've got another three buyers lined up, on hold, pending the outcome of what you guys decide to do today. It's OK if you don't want to buy. But I just need to know it today. I promised I would give these other buyers an answer by tomorrow. The house is available, and it's yours today. What would you like to do?"
I think that's the Now Or Never Close. If it's not, it should be, because it worked. They looked at each other for a long time. I can't imagine the fireworks going on in their brains, but after nearly a full minute of silence Charlie said, "let's just buy the damn house!" Candy looked at him a little longer and said, "Yeah, OK Charlie, OK". We then OK'd the paperwork, and I took a $500 check from them to bind the agreement.
From here, I gave the closing agent both the option contract I had with the sellers and the Purchase and Sale Agreement I had with the buyers and told her I was creating three owner financed mortgages and selling the First to a notebuyer, and I wanted to do a simultaneous closing, using the funds from the note sale to close on my cash purchase with the sellers. She said, "no problem."
I must admit I heaved a sigh of relief. I gathered the documentation from Candy and Charlie that I needed for the notebuyer (tax returns, pay stubs, the purchase and sale agreement), ordered the appraisal, title report, and stood by. The appraisal came in dead on $105,000. Candy called me "every" day and after three weeks she was a nervous wreck.
Finally, we scheduled a day for the closing, to execute the documents. We closed the transaction with the sellers first. Understandably Leanne and Greg were a little somber about having to part with their home, but they signed the documents, we shook hands and they left. On the other end of the spectrum, Candy's smile was a mile wide as she and Charlie bounded into the room. We chatted and I watched as they signed the mortgages that obligated them to pay me $15,500 cash now, $155 a month for the next fifteen years, and the Third that was $200 a month for ten months. Ten minutes later it was over. They gave me a lift down the road to my car, and on the way Charlie said, "Thanks Ben. We don't know how you did it, but thanks." We shook hands and they dropped me off.
The next day I got a call from the closing agent telling me that the wire from the notebuyer had come through and that I could come in and pick up my check. I drove in, signed a few more things and she slid the check across the table to me. I looked at it. $15,551. Being the professional, she proceeded to tell me that I should present my Land Trust to the bank when depositing the check, they'll want to see the paper trail. But then she let slip that, "Hey that was a pretty good deal. You put in $5, held title for ten minutes and got $15,500 back. That's not bad." I agreed and said, "It's a reaction to blocked up toilets and bouncing rent checks." We chatted a bit and I went to the bank.
|Ben Innes-Ker has been a full time real estate investor for 7 years and is author of the Motivated Seller Magnet - Automatic Lead Generating System. He is constantly fine-tuning his marketing and business systems to make his investing more profitable with less effort, so he can spend more time enjoying life with his wife and 2 young children. Ben Innes-Ker shares these unique profit making systems with his Power Marketing Members.|
|Copyright 2002-2019 All Rights Reserved. Published with Permission of Author. No part of this publication may be copied or reprinted|
without the express written permission of the Author and/or REIClub.com.
Back to Top