Not so long ago, it was common for homeowners to have to come up with a 5% down payment in order to get a conventional loan.  FHA loans required 3%.  Only VA loans could be obtained with a zero down-payment.  No seller assisted financing was permitted, however, borrowers could borrow the down payment if it were secured by collateral other than the home being purchased; but total loan payments impacted the amount of loan they could get.  They could be gifted the down payment.  They could sell something to raise the down payment; which included selling an Option on the house they were buying to an investor for enough money to provide the down payment.

         In 1981, in an effort to halt the Carter inflation that he had inherited, Reagan imposed much higher interest rates and much more stringent loan underwriting criteria.  This brought house sales to a screeching halt.  For investors, this created a new opportunity back then that will be renewed after October 1st when sellers are prohibited from assisting in home financing.  This scenario required three parties:  The first was a Broker or entrepreneur who was trying to create a sale for a better home.  The second was a credit-qualified, pre-approved buyer who needed to buy an affordable house, but who had no money for the down payment.  The third party was an investor that wanted a safe, management-free investment.

         First the seller had to get the buyer motivated to give up all future gain in return for a better lifestyle for his family today.  The seller first showed the buyer unattractive FHA houses in lower priced neighborhoods that he could afford.  Then he showed him houses in a better neighborhood that he couldn’t qualify for.  Finally, he showed him the better target house that he wanted to sell.  He explained that the buyer’s family could enjoy all the benefits of a better house in a better neighborhood, with better schools if he’d be willing to give up any gain to an investor who’d provide the down payment.  They all wound up with what they needed.  

         That was the old technique. Now, let’s update this technique for today’s market:  Joe wants to buy a great deal on a “Short Sale” house for his personal residence.  It was mortgaged for $275,000 just two years ago, but the lender wants to get the defaulted loan off his books. It is willing to reduce the loan payoff to $200,000 to a new owner/occupant buyer who has been approved for a 95% loan from a new lender.  The old lender who is being paid off will even pay the real estate commission.  The catch is that Joe has to come up with a $10,000 down payment.  The deal maker who has set this transaction up finds a Roth IRA that will pay $10,000 for an Option to buy the house from Joe for the lesser of $190,000 or the loan balance at any time after 2 years and prior to 20 years following the sale. 

         With this down payment paid into escrow, the deal closes and all the parties wind up with what they want:  The original bank gets paid off.  The financing bank gets a safe loan with a $10,000 cash down payment on a house that is clearly worth a lot more than their loan.  The Broker/deal-maker gets paid.  Joe gets into a house that he couldn’t otherwise have been able to afford.  The long term Option gives him ample time to raise his family in a better environment without having to move.  The Option is secured by a Note and recorded mortgage.  This protects the interests of the investor and the property against judgment liens.  

         Suppose after a few years the investor wanted to get his cash out of the transaction?  Joe could refinance the house and in the process buy the Option.  Or the investor could sell the Option to another investor.  If he had held it for a year, any tax on the investor’s gain could be deferred by structuring the Option purchase as a Section 1031 exchange.  On the other hand, if later on when Joe were able to qualify for a loan to buy another house, he would have the choice of selling the house for cash at fair market value and paying off the investor; or he could sell the house very quickly, “Subject To” the existing loan and the Option, at a bargain price; and let the next occupant get all the benefits of a Champaign lifestyle on a beer budget.  Or he could offer the house to the Optionee who would simply take over the loan and capture any equity that had been created by appreciation and loan amortization. 

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