The Mortgage Bankers Association predicts that home sales will drop 9% in 2005 compared to 2004 due primarily to rising mortgage rates. Some sellers will take their homes off the market and some buyers will decide to wait until rates are lower before pursuing their next home purchase. Rather than simply make a price adjustment the sales price of a home to account for higher interest rates, history has shown that many buyers and sellers simply retreat.
One solid technique to make a home more salable – and actually profit from rising mortgage interest rates – is to offer it with a below-market assumable mortgage loan. While these loans are hard to find through commercial banks, accountants and financial advisers offer them through private mortgage lenders. The fees on these loans are less than other mortgages and the interest rates are lower than most commercial loans. Potential sellers who take assumable mortgage loans now can hedge their bets in the event that interest rates continue to rise. The value of an assumable mortgage increases in the eyes of the buyer as interest rates rise, thereby offsetting any negative effect that would otherwise stall a sale.
Here is an example of how this strategy might work: A homeowner refinances her house now worth $500,000 with a private mortgage for $500,000 (that’s right 100% cash-out refinancing is possible in these programs) and signs up for an interest only payment of 5.0%1 fixed for 3 years, with variable rates after that. The new mortgage loan is assumable. The monthly payment is about $2,100 – probably less than the owner’s previous mortgage. Then, six months later the owner lists the house for sale for $600,000 with a below-market assumable mortgage for $500,000. If interest rates have gone up (as we expect them to do) then the buyer will be enticed to take over the lower rate loan. Now the mortgage itself is an asset to the seller, having the effect of raising the entire contract price. Assume a sales agreement is reached at $550,000 then the buyer puts only $50,000 down payment and may finance the difference. The buyer pays a small fee to assume the mortgage (usually 2% or less of the loan amount) that is less than the cost of getting a new mortgage loan. Of course the buyer must also meet the lender’s credit criteria. The sellers pocket the entire sales price, without the need to offer any financing themselves.
To make this strategy work, both the seller and the buyer must be working with accountants who are familiar with these lending programs. Private mortgage lenders are looking for financially strong borrowers and often take referrals only from accountants who provide financial statements and a personal recommendation in support of the loan. The accountant’s fee for this referral work is likely a little more than the cost of preparing a tax return. Even with this requirement, the total of the accountant’s costs plus the private lender’s fee is usually significantly less than the cost of obtaining a traditional mortgage loan.
Many of these private mortgages are secured by investment assets (other than and in addition to) the mortgaged property. The benefits of this strategy include:
- lower interest rates
- higher “loan to value ratio” loans – up to 100% LTV
- higher percentage tax deductions (interest only payments may be 100% tax deductible)
- insulation from negative effects of rising mortgage rates
- loans are assumable
- changeable loan programs – no need to pay refinance fees to lower rates, change terms or loan amount
- no application fees, no points
- little paperwork –applications are taken by phone and documentation is supplied by the accountant
1 The rates and calculations are assumed for illustration purposes only and are not meant to be representative of current market conditions.
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