One of the questions I see asked over and over on the REI newsgroups is “Can the seller get another loan?” This is a great question because it so often is one of the objections raised by a seller when a creative offer is being discussed.
The short answer is “yes”. Only in rare situations would a seller not be able to qualify for another loan. This, of course, assumes the seller would typically qualify if they were not going to leave their loan behind. Let's explore explanations that can be used with the seller.
If the seller doesn't sell the house and plans to move anyway, the seller will be forced to either lose the property to foreclosure or lease the property out soon.
Yes, there are other solutions, but this is what the typical motivated seller sees as their options by the time they jump on the phone and start contacting real estate investors. The above responses seem to be the two most common answers to the “What will you do if it doesn't sell?” question.
So, let's assume for discussion purposes that we are not involved at this point. If the seller finds someone to lease their property, the seller's loan will still be in place. The seller may or may not have landlording experience and may or may not have a decent tenant. Those arguments come in handy for other objections, but don't really affect the “new loan” scenario. Most lenders will give the seller a 75% income credit toward their debt ratios. For an example, assume the seller has an underlying payment of $750 and a tenant who's paying $1,000. The lender will include 75% of the rental amount, or $750, as income which will help offset the underlying debt payment of $750. It's not really a “wash”, but it's pretty darn close.
Even if the rent were only $750, the 75% rental income credit would equate to $562.50, against the monthly payment of $750. In my experience the $187.50 is usually not enough to disqualify the seller for the loan.
So, to summarize, regardless of whether you plan on acquiring the property through a lease option, Sub2, or some other form of creative financing where the existing loan stays in place, the worst case scenario should be that the new lender treats the property as if it's a rental.
If you've entered into a lease option agreement with the seller, this may work favorably for the seller in qualifying for a new loan. Again, worst case should be that the property is treated as a straight rental. Best case would be that the lender gives the seller full credit for the debt payment.
Sometimes the lenders may have different requirements to “prove” the payments are actually being made by the investor. In the past I've been asked to supply a letter confirming my agreement to be responsible for the payment. Sometimes having the seller show the lease option agreement may be enough. Other times I've had to actually round up copies (front and back) of the cancelled checks and mail those off.
As far as I know, I've never had a seller not receive full credit for payments that I'm making and the sellers will typically contact me when applying for a new loan. I invite them to do so when having the initial discussion about the Due-on-Sale (DOS) clause and the “How do I get another loan?” concern.
Generally, this will be a no-brainer if the transaction is done in a “traditional” manner. By this, I mean that a document exists that can be shown to the lender as evidence of the transaction and agreement. It could be a promissory note and deed of trust (mortgage in some states), contract for deed, or similar document.
I think that some investors become more concerned when purchasing the property subject to the existing financing (Sub2). Since many Sub2 transactions do not have a “traditional” type document that proves the purchase, a bit more effort may be needed here.
Depending on the language in the purchase agreement, this may or may not be an issue. More often than not my sellers are able to prove the sale by providing the lender a copy of the agreement. Since my agreement states that I'm responsible for the payments, this will frequently satisfy the new lender.
If it doesn't do the job by itself, adding a copy of the completed HUD-1 Settlement Statement will boost the argument. Regardless of the fact that I filled the HUD-1 out myself, it does evidence the fact that a sale took place. Until you know what you're doing, I would recommend allowing the title company or closing attorney to complete the form for you. If you're buying title insurance on the deal, it will most likely be done for you anyway.
If you do decide to do it yourself, you can get a fillable PDF copy on the Real Estate Forms page on this site. Use a copy of a prior transaction to use as a guide and/or have someone who is knowledgeable review your work.
Time for a quick side note here. Some loan officers and real estate investors will offer up the suggestion that you either create a “contingency” document at the time of purchase or backdate one at the time of the loan application. Utilizing a document (typically a Contract for Deed) that really plays no part in the substance of the transaction just for the purposes of making it easier for your seller to get another loan is not only unnecessary, but potentially fraudulent.
So, even on a Sub2 transaction which typically involves less documentation and is unfamiliar to almost every party who will be involved in the seller's loan process, proving the payments are being made shouldn't be a big issue. It may require some additional effort by the investor if the purchase agreement and HUD-1 are not sufficient proof, but the seller can qualify for a new loan and will typically receive full credit for their prior debt payments on the property.
One potential risk that I have not run across personally might be if the seller somehow ended up at the same lender who holds and/or services the first loan. Perhaps that would cause some problems, but again, this is easily addressed when having the initial DOS discussion.
To summarize, the seller can get another loan even after leaving the prior one in place and this objection should be a non-issue when discussing the acquisition of their property, regardless of which creative technique is used.