Hey there — Cam Dunlap here, with a super-interesting question I was asked by a student recently. Here it is:
“I’m talking to a retail buyer in Georgia who needs a place to live immediately. She’s tried to get a mortgage but can’t. From selling her home, she has $15-$20k cash to put toward a new place. She asked if I could seller finance the balance, which doesn’t work for straight wholesaling.
Would you recommend trying to find her a house for under $20k? Is that possible? And if that’s not possible, should I put her in touch with a private lender or structure a deal with owner financing?”
See, interesting!
So, I thought it would be good to share my response with your fine folks here at Awesomely.
Right there is a buyer who is perfect for a lease option!
Why?
2 main reasons:
- She’s got credit issues that are preventing her from getting a mortgage, which I’m sure in time will heal, assuming she doesn’t continue to damage her credit.
- She’s got $15-$20k cash to put toward a purchase.
That’s the perfect kind of lease option buyer, because when you collect that $20,000 from her, she’s going to be the best tenant-buyer ever.
Why?
Because the way a lease option works is the buyer is responsible for all maintenance and repairs on the house.
Think about it: Putting $20k toward the purchase price of the house that she will lose if she does not follow through and close on the deal, basically guarantees that she will take good care of the house and pay you — Mr./Mrs. Investor — on time because she has so much to lose.
So, then the question is: How are we going to find her house?
Well, I recommend buying a house where the payment is indicative of the market rent. So, if houses in a neighborhood are renting for $1,200 bucks a month, and that’s what the tenant-buyer can afford, perfect.
Then, find a way to buy a house like that from a seller — either by:
- buying yourself on a sandwich lease option, where you have an agreement with the seller and an agreement with the buyer
- or, buy a house with seller financing, where the seller comes back alone to you — you’re the owner, and you turn around and lease option it to your tenant-buyer
- or, find a seller who is in a jam… can’t afford their mortgage and is facing foreclosure imminently — maybe right now they’re protected by the federal moratorium but maybe not, and you take the house subject to the underlying mortgage, bring the mortgage current, and then sell it to the tenant-buyer as a lease option
For any of those, of course, the numbers have to make sense. And, the rent needs to be reasonable, so the tenant-buyer lady doesn’t find herself in a place where she’s overpaying for the house.
More details on how to handle this…
That $20k down would be her earnest money deposit. The way I’d structure that is with 2 documents.
Here’s the first:
- A purchase and sale agreement, where you lay out the terms and amounts of the purchase and the sale price; that she’s going to provide you now with $20,000 as an earnest money deposit; you would move the closing date into the future to a date that works for you and works for her and gives her enough time for her credit to heal so that she can go back to the bank, get the mortgage and cash you out
It’s best to have as much of a spread as possible between what you’re buying it for and selling it for. You could go 5% above fair retail because some people will buy a bit higher with this lease option strategy because they have damaged credit. And, you’re willing to take a risk on that damaged credit… but the $20k pretty much eliminates that risk.
So, how long should that agreement be?
What I have found in the past with buyers like this is they tend to be a bit unrealistic. They’ll tell you they can afford to pay more rent than they can. They’ll tell you that they’ll get their credit healed and close sooner than they can.
So be very careful with that!
Don’t just agree to what the tenant-buyer is suggesting. Run the numbers, look at market rents, and you might even want to talk to a mortgage broker about the lady’s situation and see what they think.
Regardless, I’d suggest at least 2 years, maybe a tad longer. What you don’t ever want to do when you’re selling a house like this to someone with damaged credit is put them in a position where they can only fail. That’s just wrong. We put these buyers in a position to win. Always.
Of course, if they insist on failure, there’s not a whole lot we can do to stop that. And, we will retain that $20,000 earnest money deposit, basically as damages.
The other document:
- A standard lease that is used commonly in Georgia. Try to get that from a local property manager.
Then, the rent is paid on the lease, and the earnest money deposit is paid on the purchase and sale agreement.
A couple final thoughts…
It’s always easier to find a house for a buyer than it is to find a buyer for a house. (I bet you’ve heard me say that before!)
And this is an example of that. Since you know what she’s got to put down, you’ll find out exactly what she can afford to pay in rent. By golly, do not let her rent exceed 1/3 of her gross income!
I’ve had tenants say to me, “Don’t worry, I can afford more,” and I’ve (foolishly) agreed. Then within 3, 6, sometimes 9 months, we both realized that was never going to work. (Facepalm.)
Rent to income ratio should be no greater than 3%.
So, I told my student all of this and then said he needed to go find her house. He has a buyer for whom he needs to find a house… and there is a $20,000 reward for finding her the right house.
See — such a great question with a terrific potential outcome.