Beware of AITD’s, Wraps, and Other Exotic Forms of Financing

Westcoe Realtors, Riverside California…Desperate times call for desperate measures…or so the saying goes…and no where does that statement rear its head like it can when it comes to real estate financing.   However, as we have all seen the past 3 years or so, desperate financing has the side “benefit” of crashing down upon one’s head, so maybe it’s best to pass on the the really “creative” financing…such as today’s topic of AITD and Wraps.

To put it bluntly, almost any type of financing where the buyer will take title to a sellers home and take over payments on the seller’s loan without notifying the sellers lender is fraught with disaster, not to mention fraud…and once you take away all the fancy words with regards to AITD and Wrap financing, that is exactly what you have.  We see these types of financing come into vogue in markets such as this, when there are a number of buyers who cannot qualify for a loan (foreclosure, job loss, bad credit, etc.), but may have some cash for a small down payment…and since the banks won’t make them a loan, they need a seller to do what the bank will not.

In AITD (All Inclusive Trust Deed) and Wrap financing, the principal is the same.  The new buyer comes in and basically takes over the sellers loan without letting the seller’s lender know.  The usual method is for the buyer to make a larger payment to the seller, and then the seller makes the underlying payment to the lender and pockets the rest.  This is usually accompanied by some agreement in which the buyer promises to get their own loan at some point in the future…but until then, the seller will simply collect the monthly money and wait.

The problem here is that the existing seller’s lender has a clause specifically in the loan that states the seller cannot let someone take over the loan.  As a result, if the lender finds out about this transfer, they will call the loan immediately due and payable because this is fraud. 

As an example, let us assume the seller has a property worth $300,000 with a current loan of $200,000 payable at $2,000 per month, principal and interest.  In the case of an AITD or a Wrap, the buyer would pay the seller $300,000, and the seller would act as the bank, carrying a new loan for the buyer of (assuming a down payment by the buyer of $10,000)  $290,000 payable at $2,900 per month, principal and interest.  The buyer would then pay the seller the $2,900 per month, and the seller would pay THEIR lender the regular payment of $2,000 and keep the remaining $900 for themselves.  Sounds simple.

Now let us count the ways this can plummet into disaster.

Let’s see.  Since the loan remains in the sellers name, who gets the tax write-off come tax time?  The bank will issue the year end statement in the sellers name, but the buyer is actually making the payments…so who gets the tax credit?  They both can’t legally take it.

What about the insurance?  The buyer needs to insure the property, but the seller cannot cancel theirs since once they do, the lender will be notified.  Very sticky here…especially if there is a claim on the insurance company (flood damage, fire, etc.).  There is a very real possibility that the insurance company  will deny the claim once they ascertain what is really happening here.  Do you really want to take that chance?

To protect the buyers interest in the property (after all, they did give the seller $10,000 and are making the payments) something has to be recorded…but recording anything that shows the seller has transferred title to the buyer will trigger the existing lender to call the loan.  Sticky again.

What if the seller is a little shady, and stops making the payments on the loan, and simply begins to keep the $2,900 per month for themselves.  The buyer would never know until way too late to protect their interest.  In our example above, since the seller would have $90,000 remaining equity, this would probably not happen…but what if the difference was much smaller, and the house value had declined?  If the seller determined that there was little or no equity left in the home, then who knows?

What if the buyer fails to make the payments, for whatever reason?  What is the seller’s remedy?  Is the buyer a “true buyer”, in which case the seller would have to foreclose on the buyer…or is the buyer merely a tenant in the eyes of the law, which would require a completely different type of action.

And if the loan gets called…lookout below.  Since the loan is still in the seller’s name, it is his credit now spiraling down the toilet…and if the seller wants to protect his credit, then the seller must now get a new loan on the property (harder to do now that it is not “owner occupied”)…and assuming the buyer still cannot qualify for a new loan, they run the possibility of losing not only whatever money they put down in the beginning, but they have no equity position for all the monthly payments they have been making.

While there are even more potential issues here, you get the idea.  Our recommendation here is that no matter how desperate either a buyer or seller may currently be, it is never wise to entertain selling or purchasing a home with this type of financing.  It just very seldom ever works in the long term. 

However, in a market such as this with more buyers having issues qualifying for a loan, we are beginning to see some if this type of financing coming out of the woodwork.  Westcoe would never recommend a buyer or seller to head down this path…but we don’t represent everyone…so if you are being asked to go this route, either as buyer or seller…BEWARE…THIS DOG COULD COME BACK TO BITE YOU VERY HARD.

Take care out there…its a goofy real estate world.