Craven Academy: Real Estate

Let's use an example. We'll assume that a property has an After Repair Value (ARV) of $300,000 and needs $30,000 in repairs. Using our formula we determine that we are willing to pay $180,000.

(ARV x 70%) - Repairs = Maximum Offer ($300,000 x 70%) - $30,000 = Maximum Offer $210,000 - 30,000 = $180,000 Maximum Offer

For our example we'll assume that the foreclosure sale is about to happen and the seller would need to bring the loan current and pay the legal costs associated with the foreclosure action in order to halt the process and reinstate the loan. If the loan balance was $150,000 and the amount needed to reinstate the loan was $10,000 in payment arrears and costs, the seller would have a total indebtedness of $160,000.

If we were to agree on a price of $180,000, we would need $30,000 in cash since we are keeping the existing mortgage. We would use $10,000 to bring the loan current, leaving $20,000 to be paid to the seller. The reason a seller would agree to this is that they are about to lose their home and would most likely be left with nothing. In a case like that, $20,000 could be enough to help then get a fresh start. In this type of scenario it is a good idea for the seller to walk away with some money. If they are faced with the prospect of selling their house and walking away with nothing, they may feel that this is just as bad as a foreclosure.

From a buyer's perspective the primary risk is that the lender learns about the transfer and invokes the "due on sale" clause. The mortgage documents clearly state that the loan is to be repaid upon sale except in case where it is an assumable loan. If the loan is not paid, then the lender will start the foreclosure process. The amount of time it actually takes to foreclose on a house varies from state to state but it is usually at least four months and in many cases longer. The length of the foreclosure process gives you time to complete the flip and sell or refinance the property. The reality is that most lenders will not know that the property has changed hands if the payments are current. If a loan goes into default status they will check the ownership at that time.

How you actually hold title in a subject-to deal varies from state to state. In some cases it should be held in a land trust, in others an LLC. If you plan on using this method, you should learn as much as possible about the local laws. While it may not be illegal to do these deals, you are circumventing the rules of the mortgage and need to consider the various risks involved as well as ethical considerations.