Lease with option to buy (aka rent-to-own) is a viable solution for many sellers and buyers, yet it is largely under used. Browsing through the various real estate blogs there are many people asking questions that often go unanswered or receive the same type of safe/fluff answers every time. As we have navigated this process from start to finish and seen it work, We’d like to dissect this topic in hopes of shedding some light on a very viable method of transacting real estate.

A lease with option to buy is an agreement to lease a home with the option to buy it before a certain future date at an agreed upon price. This type of agreement is ideal for someone who is either not ready to buy because of a lack of assets or credit or a lack of desire to risk their assets or credit. Even though this is not a new concept it is largely under-developed and there are many things to consider for both sides of the transaction. We cannot stress enough that having an agent that is experienced in this type of transaction is something that should be strongly considered by both sides.

How much should the rent be?

The rent should reflect current market prices for comparable rental units plus additional amounts that may go towards purchase of the home or payment for the option. However, all three of these rent components are negotiable so this is a great reason to have an agent working with you who is experienced in this type of transaction. The key is for the seller to be appropriately compensated for taking the risk of future price depreciation while forfeiting all price appreciation to the buyer.

How much should the rent be increased to fund the future purchase?

As mentioned above, this is negotiable. Again, because this process is rarely used there is no standard or often used guideline to consult.  However, incorporating an extra amount into the rent to fund a future purchase amounts to nothing more than the seller operating a savings account for the benefit of the buyer. Does the seller really want to be in the banking business? And from the buyer’s perspective, how is this any different than the buyer starting a savings account and putting that extra money in there for an eventual purchase that doesn’t tie them to a particular unit? The only difference is that under this arrangement the buyer is “forced” to save money for their purchase. Interestingly, the Chicago Association of Realtors has a “Lease With Option To Purchase” rider that doesn’t even provide for such an accumulation fund.

How should the accumulation fund be managed until it’s time to buy?

There are a couple ways to go about this and it is largely affected by the profile of the seller. Is it huge profitable developer or a struggling couple that is trying to sell? First of all, if it was agreed that the monthly rent would be increased by a specific amount each month (above market price) and that amount would be put toward the eventual purchase, that money should be put into a separate escrow account by the landlord/seller until such a time as it will be used for the purchase or refunded to the buyer/renter. Another way this can be handled is for the landlord to keep a ledger to record the agreed upon amount so that when the time comes to purchase, the landlord will reduce the sale price on the home by the amount in the ledger. From experience this is the most common method, however a number of risks for the buyer present themselves. Namely when the time comes to sell will the landlord be able to sell the home at the reduced price? In addition, lack of funds for a down payment is a very common reason that buyers seek a lease with option and it is not necessarily the price of the home that is preventing them from buying. Often the amount of money accrued is a drop in the bucket when compared to the over all cost of the home and as such the highest impact of that money would be as down payment assistance for the buyer. If the landlord is not keeping the money in escrow, there is no guarantee that the landlord will be able to cough it up at the closing table.

At what point in the process should we agree on a purchase price?

In the Chicago Association of Realtors “Lease With Option Rider” there are two choices (this may differ for your local association’s forms, please consult your agent):

“Tenant shall have the one-time right to purchase the Property (“Purchase Option”) for a purchase price equal to (strike one) $_______________________________ / the fair market value (“FMV”) of the Property at the time such Purchase Option is exercised (“Purchase Price”). (Strike the following sentence if it does not apply) The FMV of the Property shall be determined by Landlord and Tenant, in good faith, taking into consideration the purchase price for properties similar to the Property, located in the same geographic area as the Property, which have been purchased in the preceding nine months. “

There is a lot to consider here. When does the renter plan on converting himself or herself into a buyer? Will it be six months or two years? What does the housing market look like at the time of purchase? Is it stable, falling or experiencing growth? Either way there is risk involved for both parties.  In a standard option there is an agreed upon purchase price, the “strike price”, established at the point at which the option contract is entered into. It is this set price that creates the value of the option for the buyer. If there is merely an agreement to negotiate a fair market value at some point in the future then the option has absolutely no value whatsoever.  If the buyer ends up purchasing the property at fair market value in the future then they have forfeited any right to appreciation of the property up to that point in time.  What if the buyer and seller can’t agree upon a fair market value in the future? This essentially provides an out for the seller. In other words, the seller is not really obligated to sell the property and the buyer doesn’t really own an option.  The existence of this second alternative in the contract is really rather pointless. It creates a situation where the seller can’t sell the property to anyone else, but the buyer is not guaranteed that they will be able to purchase it for a price they consider reasonable.

As a seller, when should I ask for a pre-approval?

This is a tricky one because in many cases the reason people are looking for a lease with option is because they cannot yet qualify for a loan for one reason or the other. Our advice is this: With the assistance of a lender you or your agent are comfortable with, get the renter/buyer pre-qualified for the purchase amount you’ve negotiated and find out what it would take for them to be able to qualify. It could be increased assets or it could be credit clean up. Whatever the case may be, this will give them a clear picture of what their goals need to be in order to eventually purchase the home. This is also very important because this will give them a glimpse of what their monthly cost to own would be. A lot of first time home buyers have no idea what their mortgage, insurance, taxes, and assessments (for condos) will add up to. It may be that once they see what their monthly cost to own will be that they realize there is no way they would be able to ever buy this in the near future. The last thing a seller wants is to waste time renting their place when their goal is to attract a buyer. Getting the pre-approval done up front is also a good way for the seller to assess the risk of a given buyer. At the beginning this will serve as a credit check, which most landlords require anyway. If you see that the potential buyer has a 300 credit score and has never paid a bill on time, it may not be a good idea to tie your home up with that candidate. If you see that they are 800+ credit, never missed a payment, and the only thing preventing them from buying is a lack of down payment or lack of income, you may consider this to be less of a risk than the former example. Obviously the buyer will need to get re-approved once the purchase is close at hand.

Will the security deposit be handled separately from the earnest money?

We recommend that these two be handled separately. Through the Landlord Tenant Ordinance (LTO) the City of Chicago requires a lot from the landlord with respected to the security deposit and noncompliance comes with some very heavy penalties. That said, we feel that the seller acting the part of the landlord should adhere to the LTO and ask for earnest money if and when a purchase comes to fruition. This will reduce the liability to the landlord who is at significantly more risk than the potential buyer.

Should I keep my home for sale during the agreement?

Only if someone will buy it with the option attached. You gave the buyer/renter the right to buy the place and you can’t just ignore that fact. Again, consider the comfort level of the buyer. Do you think a buyer would go through all of this trouble with the possibility that the rug can be pulled out from underneath them at a moment’s notice? Plus a renter who is planning on buying this home may be very put out by having “potential buyers” traipsing through the home.

What happens if the home is foreclosed during our agreement?

This situation is largely effected by the type of agreement you had. If you are paying above market rent and having that money put into an escrow account, obviously you should have claim to that excess money. We recommend that you have some verbiage in your agreement that covers this possibility no matter how remote you think it may be.

Can section 8 vouchers be used in a rent-to-own home purchase?

The answer according to the HUD website is yes, depending on your personal situation and the program that you are involved with. We advise you to consult the hud.gov website for details.

Do I have to sell my home at the end of the agreement?

Absolutely. That’s the whole idea behind an option and that’s what you are being paid for.

In Conclusion

With all of the different variables to consider it is clear why a lot of agents steer clear of this type of transaction. It is unfortunate that often the professionals that people turn to for advice are the ones that push them away from viable options due to lack of familiarity or out of sheer laziness (short sales are another example of this). In the end, rent-to-own has the potential to be a win-win situation for all parties involved. The buyer gets a chance to test out a home before buying it, continue to build credit, and an opportunity to put their money toward a home purchase prior to qualifying to do so. For sellers, they can have a renter in the short term to help alleviate some of the financial burden of their cost to own while cultivating this renter into a buyer. The situation can also be a very easy out for both parties. In a market where serious buyers are hard to come by, this has the potential to be an excellent compromise.

I asked John Reim, from Bee Sure Home Inspection Services, to write a guest post this week on how to choose a home inspector. As with real estate attorneys, your realtor may have recommendations but you need to be armed with a bit more information so that you are not at the mercy of your realtor. After all, your realtor may have a fairly obvious agenda.

A home inspection is a comprehensive visual examination of the physical structure and systems of a home, from the foundation to the roof.  A home inspector is trained to be a detective in regard to the construction and working parts of homes.

Buying a home can be stressful and requires countless important decisions.  When you find a house you should hire a thorough home inspector to inspect the condition of the home and give you a detailed home inspection report.  Hiring a home inspector is a wise decision, even when buying a newly constructed home.  Having a detailed inspection report before you move in will prepare you for any potential problems and set your mind at ease.

Why hire a home inspector?

A home purchase may be the largest investment of your life.  Before you purchase the property you should learn as much as you can about the home and its systems, including what may need to be repaired and what kind of lifespan is remaining on the major systems.

A home inspection will also point out the positive aspects of a home, as well as required ongoing maintenance that will be needed to keep the property in good shape.  By having a professional home inspection you will have a clearer understanding of the home you are purchasing so you can make a confident decision.

What if the home inspection reveals problems?

If a home inspection reveals problems it does not necessarily mean you should not purchase the home.  The home inspection is meant to educate you in advance of the purchase of the condition of the property.  Quite often, a home inspection and its findings become a vital tool in the negotiation process between the buyer and seller of the property.  A home inspector is barred by law from providing an opinion to the question “should I buy this house?” or “if it were you, would you buy this house?”  Ultimately it is up to the buyer, their agent, and the attorney to decide which inspection items you wish to pursue for repairs or credits.  It is suggested that you try to avoid minor items and pursue the larger items in order to avoid unnecessary conflicts.  Keep in mind that there is no such thing as a “perfect house” and all homes have some type(s) of deficiencies.  It is your responsibility to be an informed buyer.  You should always be sure the house you purchase is satisfactory.  A careful examination of your potential new home is crucial in this process and could save you a great deal of money in the long run.  Potential problems that are identified in the inspection will often require further evaluation by specific specialists (i.e. HVAC professionals, Electrical Contractors, Roofing Specialists) to determine courses of action for repair/replacement or cost estimates.  The inspector is not a specialist, but is rather a generalist, with training and education which can help them identify potential problems with the major systems of your home.

How do I choose a Home Inspector?

What will it cost?

First, always take the time to research any home inspectors you consider hiring.  The most common question a home inspector receives during the hiring process is “how much does the inspection cost?”  This is often the first question asked as most homebuyers are unaware of what else to ask.  Keep in mind that home inspections are similar to other purchases that you make on an everyday basis, in that you often get what you pay for.  Since a home is without a doubt the single largest investment you will ever make it does not make sense to skimp on the inspection in order to save a few dollars.  Beware that like in any other business there are inspectors out there that will do your job on the cheap in order to make a quick dime.  The risk with this is of course having an inspection that is not overly thorough and might just do what is required to meet the minimum standards.  Though cost is certainly a relevant question, there are many other more important factors to consider when choosing an inspector.

How long have you been inspecting houses?

Ask your potential inspector how long they have been in business.  Many “newbie” inspectors will charge lower fees but may have very little experience when it comes to performing residential inspections.  These inspectors may or may not be around a year or two down the road to answer questions or address potential problems should they arise.  Ask how long they have been inspecting homes and how many inspections they have performed.

Is the inspector licensed?

Do not hire an inspector that is not fully licensed.  Though the state does a fairly good job of regulating the inspection industry, there are still incidences where inspectors are performing inspections without proper state licensing.  This is illegal and should you find an inspector who is not licensed you are encouraged to report them to the Illinois Department of Professional Regulation.  State licensed inspectors are required to follow a strict guide of ethics and inspect to state standards.

Is the inspector fully insured?

It is a good idea to make sure your inspector is fully insured to protect your investment.  A reputable inspector should carry both general liability and errors and omissions insurance.  This protects the buyer should the inspector accidentally miss something critical during the inspection process.

What is the inspector’s background and history?

Get some background on your potential inspector.  For instance, find out what they did prior to becoming a home inspector.  Though not required, an inspector with past experience in the building trades would be a better candidate than one who was previously a circus clown.  Some inspectors may have previously been tradesman in certain areas such as plumbing, electrical, or HVAC.  Though they may have extensive knowledge of these particular systems, keep in mind that a good inspector is knowledgeable in all areas of the home.  If you know of particular areas of concern with the home you are considering, it might be wise to find an inspector who may have extensive experience in that area.  For example, if the home has a history of water infiltration you may want to consider an inspector who has knowledge of water intrusion or mold assessment.

What type of report does the inspector provide and what is in it?

Some inspectors provide low quality hand written checklist style reports.  Though this was standard in the industry ten to fifteen years ago, times have changed.  Quality inspectors now provide clear streamlined computerized reports which can be delivered quickly via electronic means.  Reports should not be limited to basic checklists, but should contain written comments and summaries on the home and its systems.  Reports should contain detailed information on each system including the condition, the age, and possibly the life expectancy of particular systems.  It also is a good idea to have an inspector that provides digital photographs of the inspection, as this provides further documentation of potential deficiencies of certain systems and can help clarify exactly where and what the potential problem may be.  This is useful especially for attorney review of the report, and to help the seller identify what may need to be repaired prior to closing.

Is the inspector affiliated with any professional organizations?

It is a good idea to choose an inspector who is affiliated with a reputable national or local inspection organization.  Associations such as NACHI (The National Association of Certified Home Inspectors), ASHI (American Society of Home Inspectors), and NAHI (National Association of Home Inspectors) all have very high qualifications for membership.  These inspectors will often inspect to a level above and beyond what the minimum state requirements may be.  Typically they also require their members to fulfill continuing education requirements that are also well above state minimums.  Member inspectors have to follow strict codes of ethics and pass routine examinations in order to maintain membership status.

Referrals

The best way to choose an inspector often is to ask friends, relatives, or co-workers who may have recently had an inspection performed who they used and how their experience was.  Would they recommend that inspector or suggest you look elsewhere?  Sometimes a realtor or real estate attorney may have suggestions on who to use.  This is a fine source of information, but you are encouraged to do your own research on the inspector.  Find out why they recommend the inspector as opposed to someone else.  Quite often you will find there may have been an instance or instances where these inspectors may have done a stand up job or went above and beyond the call of duty in order to protect the interests of their clients.  It is also perfectly acceptable to ask your potential inspector for a list of references or client testimonials.  This may help in your decision making process.

John Reim
Bee Sure Home Inspection Services, LLC
389 Rock Hall Circle
Grayslake, IL 60030
(773)425-8275
jrinspect1@gmail.com

I was poking around this morning doing some research on enhancing real estate searches for our Web site. We’re about to introduce building specific searches. While testing the listings for 340 On The Park I discovered that we are only allowed to show 9 listings, while there are actually 15 units for sale in the building. Why can’t we show those other 6 listings? Well, we could if we required you to register but we don’t want to do that because registration is a pain in the ass. Furthermore, it’s a real turn off for real estate buyers who are afraid that some pushy real estate agent is going to start harassing them – not to mention that many home buyers provide bogus registration information when faced with that requirement.

But why do we have to get you to register to see these other 6 listings? Because the real estate brokers that are listing those units do not participate in an arcane and convoluted program called broker reciprocity. As explained in that prior post real estate listings from brokers that participate in the program get put in the IDX feed, which is broadly available on all realtor Web sites without registration. If a broker does not participate, their real estate listings are only available in the VOW feed that requires registration to access on a realtor’s Web site.

What is surprising about the 340 On The Park situation is that 6 out of 15 listings are not in the IDX feed. That’s a huge number. Just the other day I did a quick estimate and determined that in the city of Chicago only about 2 – 3% of the real estate listings are missing from the IDX feed, which is consistent with what the MLS folks tell me. That’s the reason that we decided to not require registration on our site.

So why is 340 On The Park so different? It all comes down to the dominant broker in the building who has all 6 of those listings. Apparently, this broker does not participate in the reciprocity program. This is especially peculiar in light of the fact that a real estate broker has to actually go through the trouble of opting out of the broker reciprocity program. In addition, opting out of the program only prevents the listings from showing up on other realtors’ Web sites. The listing brokerage still has the ability to advertise the listing on any Web site they choose – e.g. Realtor.com, where these “missing” listings do appear and without registration. So the listing brokerage selectively withholds access from the Web sites of brokers like us who refuse to require registration for accessing MLS listings (we still have access to the properties through the MLS system but we can’t put them on our Web site without requiring registration).

All of these shenanigans highlight yet another problem you can run into using the top producer. So, if your home is currently listed and you want to find out if your realtor is holding out on you just check for your home on our site. If it doesn’t show up then it’s not getting the broadest distribution possible.

As I asked before, why would any broker not want their listings to receive the broadest exposure possible? Could it be that they are trying to restrict access to their listings so as to increase  the likelihood of their getting both sides of the transaction? Nahhhh. A real estate broker would never put their own self-interest above that of their client.

The following 10 steps are meant to provide a short overview of the steps that one should take in the home buying process.  While it is by no means a comprehensive list -it provides valuable tips and reminders to all home buyers.

Figure out how much you can afford
Talk with a mortgage professional.  In fact, talk to three mortgage professionals.  Not all lenders are created equal, there are bankers and brokers.  Get good faith estimates.  Compare bottom line only…meaning don’t just look at the rate being offered, consider all closing costs related. Get pre-approved, not pre-qualified.

Choosing the Right Property Type
In order to determine the best property type for you, think about how much you can afford and your reasons for buying. Each property type comes with its own pro’s and cons.  After consulting with a lender, you will know what you can afford in terms of dollars.  Now, you need to decide amongst a Condo, Townhouse or Single Family Home.  In fact, it may be more difficult to obtain financing on a condo than a single family home.  It is important that you consider the goals for your real estate purchase, both short term and long term. For example if it is going to be your primary residence, you want to make sure it can comfortably accommodate your current and future family i.e. children or in-laws. If the market takes an unfavorable turn and it become difficult to sell then you can still live comfortably in your home until the market recovers.

Finding the property
Now that you understand your budget and the type of property you are looking for, its time to start looking. So where do you start? I recommend finding a local real estate professional.  Buyers’ agents are paid at closing by the seller, not by the buyer.  The total commission is generally split between the buyer’s agent and the listing agent.   Bonus: If you choose a buyer’s agent from Lucid Realty you can receive up to 50% of their commission at closing. Basically, you are getting a “free” high level service and money in your pocket.  Your agent will want to know about you and how you like to live and other important criteria.  From there, the agent will send you properties to review and view in person.

You found the property
Before placing an offer on a home you should know how much it is worth to ensure the listing price is in line with the actual value.   Your agent should provide you with a CMA (Comparative Market Analysis). A CMA compares homes based on size, location, condition and several other factors to estimate the value real estate in a given area.  Hopefully, it will give you a better understanding of the local market.  It is also important to understand that everything is negotiable.  A good agent will help you learn as much about the seller and the property as possible.  It also is important to include contingencies in the offer as well. The most common types of contingencies are a mortgage contingency and an inspection contingency.

Hire A Real Estate Attorney

Once the offer is accepted, get it to a real estate attorney to review. Real estate brokers and agents are professionals at finding an ideal home and negotiating the terms, but attorneys are experts at reviewing and explaining contracts. As a result, it is best to have an attorney review all contracts before entering into any agreements with the seller. The best way to find a good attorney is to ask your real estate agent. Real estate agents regularly work with a number of attorneys in many different capacities and know which attorneys will be best based on your specific needs.  It is in the agent’s best interest to recommend an attorney that they know is competent, trust worthy and focused on protecting their clients’ interest.  It is also advisable to use a real estate attorney as opposed to a family friend who specializes in any other law to get the best representation.

Hire a Home Inspector
A home inspection is an essential part of the home buying process.  A home inspection will validate that you are investing in a good home or uncover significant defects that you would otherwise not have known about until moving into the home.  It is far more valuable to know what you are buying before you buy.   So what happens when defects are discovered by the inspector? In most instances the buyer and seller come to a mutual agreement on how to deal with the issues. Sometimes the seller may agree to take care of the issues. In other instances the buyer may assume the responsibility for a discount in the price. It really just depends on the specifics of the defects. As a buyer, it is best to know as much about your home before you purchase it as possible.  One word of caution:  be prepared for seeing a laundry list of really scary issues. This is normal. Many inspectors relish the idea of finding problems and some tend to exaggerate how bad things are.

Mortgage Application
Once of all the terms are finalized following the home inspection, complete your mortgage application. The first step would be to provide your lender or bank with the real estate contract.  In most cases, your agent will take care of this step for you.  They will ask for a signed copy of the contract along with other financial documents needed to complete your loan application. It is important to get this application in as soon as possible so the bank has as ample time to process your application. In accordance with the contract, the bank must provide the buyer with a commitment letter by a specific date. The commitment letter states that the bank is going to give you the loan. If the lender does not supply this by the specified time, they buyer runs the risk of forfeiting their earnest money.   You won’t lose your money if you don’t get your commitment in time but you may have to walk away from the deal or you have to ask for an extension – which can scare the hell out of the seller.

Get Insurance
After the bank provides a commitment letter, the only additional requirement from the buyer s the insurance binder. Before the bank can complete the loan the buyer must purchase home owners insurance.  Again, talk to three people.  Perhaps start with the person who insures your automobile – or perhaps one your agent recommends. The insurance binder is then sent to the lender prior to closing. Now the funds are all set to be released on the specified closing date.

Review the HUD
1-2 Days before you close, your attorney will provide you a settlement statement (also called a HUD) for your review. It is important that you, your attorney and your Realtor review the charges, fees and adjustments to ensure everything is correct. The HUD will have all of the information such as the closing costs, tax adjustments, utility adjustments your real estate rebate and several other fees. It will also state the amount you need to bring to closing. Any funds brought to the closing should be done in the form of a certified or bank check.  We recommend that you bring at least a few hundred more to closing to help avoid any unforeseen issues.  If you bring too much, the title company will issue you an overage check.

Closing Day
So what do you need to bring to the closing? You will need at least 2 forms of identification, and a certified or bank check for any additional funds.  The closing is typically attended by the buyer(s), seller(s), closing attorney, your attorney and the real estate agents involved in the transaction.  Your attorney will explain all of the documents to you prior to signing any of the disclosures at the closing. Once you are finished signing, you will receive your keys. Congratulations! You get your keys and now its time to figure out how you are going to spend your rebate!

For example, just yesterday I closed on a deal as a sales agent.  Several times throughout the course of the transaction, the deal was ready to fall apart.

First, the negotiations were almost killed over a few thousand dollars.  The seller came down as far as he wanted to, and the buyers offered as much as they could afford.  Both the listing agent and I were able to talk to our clients and get them to come down/up and then we had a deal.  Keeping calm and rational was key.  It was also important to ensure my client was seeing the big picture.  They were getting a nice home in a great neighborhood….there wasn’t anything better on the market that we found after seeing about 50 homes.

Then, the inspection report totally freaked out the first time home-buyers.  A list of more than 25 necessary repairs was noted by the inspector. At that point, it was in my hand to help the buyer understand what they should expect to be fixed and what they might accept since they were buying a used home.  More importantly, it was also in my hand to set the expectations with the listing agent as to what my clients would be asking for and WHY.  A verbal conversation can convey so much more than a letter drafted by an attorney.  At any rate, my client asked for certain repairs, and the seller agreed.  Whew.

Well, then came the appraisal/FHA inspection to approve the loan…which we figured would be fine since the seller had agreed to repair all the safety related items from the home inspection.  The FHA inspection in fact didn’t care about any of the issues identified (roof leaks, improper electrical wiring) BUT they wanted a fence painted or removed from the perimeter of the property.  The property lot size is 100 X100, which mean 1000 feet of fencing needed to be removed.  The house was built prior to 1978 and the fence paint was chipped and the logic was that it could have been lead based paint.

Objection #1 – Seller doesn’t want to take the fence down or paint it.  He didn’t want to incur a cost or go through the trouble, after all, he had already agreed to the other repairs.

Rebuttal – My clients will remove the fence on their own dime, but since it was a requirement of the loan, the removal had to occur prior to property transfer, and this of course presented its own set of issues. My client may not get the house and thus his labor would be wasted.  Okay, they decided to take the chance.

Objection #2 – If the buyer doesn’t get the loan, the seller now has an unfenced property.  He feels the fence is attractive to buyers, and while the fence was great – I couldn’t help but agree.  Kids and pets typically necessitate a fence.

Rebuttal – My client will waive their mortgage contingency, and the lender has provided a mortgage commitment document.

Objection #3 – Removing the fence will cause a devaluation of the property upon inspection.

Rebuttal – Okay, this objection was close to killing the deal.  Thankfully, the appraisal specifically stated that the fence had “No contributory value” which meant the value of the property was the same with our without the fence.  Nonetheless, my clients agreed to put the fence back up if for some reason they could not take ownership of the property.

Of course, all of this was occurring a week prior to closing and my clients current lease is up at the end of the month, so it was pretty crucial that we got it done in time for a re-inspection.  What did that mean?  That meant my client, who happens to be a female had to physically remove the fence herself, since her male partner was out of town.  She solicited her father for help.  I felt pretty bad about her predicament so my mother and I helped as well.

Bottom line, I knew my clients wanted this home and I knew it was a good value.  It sure would have been easier to let the attorneys hash all of the issues out – but I’m pretty sure that staying on top of all the details and ensuring constant verbal communication got us to the finish line.

The word “title,” can mean a number of things. In real estate, “title,”refers to one’s right to ownership, or any form of evidence of land ownership. Title is your rights to the land and improvements.

 What is Title Insurance ?

Title insurance is a protection mechanism that will protect you against any kind of damage caused by a defect in the title. Defect in a title?  What?  A title can be defective for a number of reasons such as forgery and impersonation.  Title insurance will protect against such defects as well as  the expenses incurred in defending the title (your right to ownership). Title insurance not only verifies ownership, it will also detect any possible “clouds” on your title. Clouds?  Unlike a defect,  a cloud implies that the title is not clear and these clouds could be in the form of IRS claims, liens, or other uncertainties of ownership.

Further, there are two different title insurance policies issued in every real estate sale. The first type is an owner’s policy, which will protect the new owner from any ensuing claims to the property. The second type is a lender’s policy, which will protect the lender against loss of an unpaid loan balance in the event of a claim.

Title insurance policies are important because they protect against possible non-recorded claims against your property and ensure free and clear ownership. As such, these policies benefit consumers in establishing safety and security in owning real estate.

To ensure the property is free to transfer title, the Title company will perform a search on the property using a “pin” or “permanent index number” which is each parcel of lands own unique ID number.  The title company will collect information about the property that is found in public records such as: the county recorder’s offices; property tax records; sometimes in county courthouses.  

Who Pays for Title Insurance?
Title can be paid in a number of ways, but the most common is for the buyer and the seller in a transaction to pay for  a policy. There are two types of policies: a lender’s policy and an owner’s policy. As far as the lender’s policy goes, it is usually paid for by the buyer of the real estate. The owner’s policy is paid for by the seller of the real estate.

Officially, a closing is the culmination of the entire real estate transaction and here is what happens:

• Documents that tranfer the ownerhsip of the property from one party to another (conveyance) and other required instruments are signed and delivered
• A monetary accounting is conducted between the parties based upon the Real Estate Settlement and Procedures Act (RESPA)
• Parties determine if condition of title is acceptable
• Funds are deposited with title company
• Money, in the form of checks is given to the Seller, Listing Agent, Selling Agent and on occasion the buyer, the buyer/seller attorney (referrred to as disbursements) per the HUD-1 by the Title company (escrowee) as directed by parties
• Ownership of the property is transferred
• After closing, the documents of conveyance are sent to the county recorder’s office for recording by the Title company

Below is a chart that shows the common costs in a real estate transaction along with who is typically responsible for paying them.  The chart was provided by First American Title. 

Lenders look at  ratios when they consider your application for a mortgage loan. A debt-to-income ratio is your monthly expenses compared to your monthly gross income. Lenders consider two ratios for your application:

• Monthly housing expenses as a percentage of income
• Total monthly debt as a percentage of income

Both ratios are important factors in determining whether the lender will make the loan.

Lenders usually require the PITI (principal, interest, taxes, and insurance), or your housing expenses, to be less than or equal to 28% of monthly gross income. Lenders call this the front-end ratio. In other words, if your monthly gross income is $5,000 or $60,000 annually, your mortgage payment should be $1400 or less:

$5,000 x 28% = $1400 – maximum monthly housing costs

Lenders usually require housing expenses plus long-term debt to be less than or equal to 33% to 36% of monthly gross income. Lenders call this the back-end ratio. In other words, if your monthly gross income is $5000, the combination of your mortgage, $1400, and other long-term debt should be no more than $1800:

$5000 x 36% = $1800 – maximum total debt

If your debt-to-income exceeds these ratios, talk to your lender about your options.  Some lenders allow up to a 41% back end ratio.

BASIC MORTGAGE OPTIONS

15-YEAR MORTGAGE

• Lower interest rate
• Build equity faster
• Less interest to pay
• Larger monthly payment

30-YEAR MORTGAGE

• Higher interest rate
• Build equity slower
• Can deduct more interest
• Lower monthly payment

FIXED RATE

• Interest rate stays the same for the term of the loan
• Interest rates could go down while you are locked into your mortgage at a higher than market rate

VARIABLE RATE

• Interest rate can increase or decrease during the term of the loan
• You might have a low rate for an three, five, seven, or ten years
• Monthly payments can be lower than fixed rate loans

BALLOON MORTGAGE

• A loan that has level monthly payments that will amortize it over a stated term (e.g., 30 years)
• Requires a lump sum payment of the remaining principal balance at the end of a shorter term (e.g., 10 years)
• Interest rate stays the same for the term of the loan

QUESTIONS AND CONSIDERATIONS TO USE WHEN CHOOSING A LENDER

BASIC INFORMATION ABOUT THE LOAN	Mortgage 1	Mortgage 2	Mortgage 3
Type of loan (fixed rate, variable rate, conventional, FHA?)
Minimum down payment requirement
Loan term (length of loan)
Contract interest rate
Annual Percentage Rate (APR)
Points (may be called discount points)
Monthly PMI payments (mortgage insurance)
How long must you keep PMI?
Estimated monthly escrow for taxes and insurance
Estimated monthly payment (principal, interest, taxes, insurance, PMI)
FEES: lenders have different names for similar fees. Listed below are some of the fees you may see on loan docs.
Application fee
Origination/Mortgage broker fees (may be quoted as points, origination fees, or interest rate add-on)
Lender fee
Appraisal fee
Recording fee
Credit report fee
OTHER COSTS AT CLOSING/SETTLEMENT
Attorney Fee
Title search/title insurance
Can any of the fees or costs be waived?
Estimated prepaid amounts for interest, taxes, hazard insurance, payments for escrow
State and local taxes, stamp taxes, transfer taxes
Flood determination
Prepaid PMI
Surveys and home inspections
PREPAYMENT PENALTIES
Is there a prepayment penalty?
If so, how much is it?
How many years does the penalty period last?
Are extra principal payments allowed?
LOCK-INS
Is the lock-in agreement in writing?
Is there a fee to lock-in?
When does the lock-in occur (at application, approval or another time?)
How long will the lock-in last?
When the rate drops before closing, can you lock-in at a lower rate?
IF THE LOAN IS AN ADJUSTABLE RATE MORTGAGE
What is the initial rate?
What is the maximum the rate could be next year?
What are the rate and payment caps each year and over the life of the loan?
What is the frequency of rate change and any changes to the monthly payment?
What is the index the lender will use?
What margin will the lender add to the index?
OTHER IMPORTANT CONSIDERATIONS
Will I work directly with you for the entire process?
What are the closing costs?
How long does it take to close from application date?

HOMEBUYER ASSISTANCE PROGRAMS

There are a number of different programs available for first-time homebuyers. The following are just a few examples of the programs available.

FEDERAL HOUSING ADMINISTRATION (FHA) INSURED LOANS

The 203(b) is the most common FHA loan, featuring:

• Low down payment
• Flexible qualifying guidelines
• Limited lender fees
• Maximum loan amounts

DEPARTMENT OF VETERANS ADMINISTRATION (VA) INSURED LOANS

Features of VA loans include:

• You must be an eligible veteran
• There are no down payment requirements
• Competitive and negotiable fixed interest rates
• Limitations on closing costs
• Longer payment terms

There is both a “streamlined” and regular version of this loan. The streamlined version has less cost and hassle and is only available to owner occupants and investors are not allowed. The FHA 203(k) streamline loan is available to borrowers of all income levels, to homeowners who plan to occupy the house, and for homes with one to four units.  There are three types of loans currently available, 15 or 30 year fixed or one-year arms.

According to the FHA website, there are three uses of the 203(k) loan:

• “To purchase a dwelling and the land on which the dwelling is located and rehabilitate it.
•  To purchase a dwelling on another site, move it onto a new foundation on the mortgaged property and rehabilitate it
•  To refinance existing indebtedness and rehabilitate a dwelling”

My post will focus on using the 203(k) loan to buy an uninhabitable property that is being sold in “as is” condition.

When shopping for a foreclosed property, the first thing to consider when choosing a lender is: Are they able to offer you this type of loan?   If not, and your property needs improvement prior to occupancy, you should find another lender.  Lenders who are able to provide the 203(k) loan can be found on the HUD website.

The following property types are eligible:

• Condos
• Town Homes
• Single Family Homes
• Mixed Use (Storefront)

To obtain a 203(k) loan there is a minimum $5,000 requirement of eligible home improvement projects on the existing structure of the property. Minor or cosmetic repairs may be included after meeting the first $5,000 worth of repairs.

Of course, if you are buying a condo, you will also be subject to minimum down payment and credit score requirements, which you can read more about here. In addition, only 25 percent of the total number of units in the development can be undergoing rehabilitation at any one time.

Another factor important to be aware of is that an approved HUD Consultant must oversee the repairs.  The process begins with a feasibility study, overseen by an approved consultant. Through this process, the FHA determines whether the improvements would be justified upon completion.  If the estimate of the property’s value after the repairs required in the feasibility study does not equal or exceed the loan amount, then no loan will be granted.

Prior to the start of any work, the consultant will provide a work write-up, which is an item-by-item breakdown of each item to be repaired and the estimated cost. Once agreed upon, the lender will order an appraisal based on the write-up. The appraisal will give an “after-improvements” value. After this step is complete, contractor bids can be solicited. Acceptable bids cannot exceed the cost given in the write-up.

After this step is complete, the loan goes through the normal underwriting and closing process and an initial payment for the purchase of the property is made. The lender holds the remaining funds until the work is completed. As the rehab progresses, requests can be made to pay contractors for work done to that point. The consultant will perform an inspection, and upon approval the lender will release the requested funds. This continues until the completion of the project. If money is left over, it can be used for additional improvements, or reducing the loan’s principal balance, but it cannot go back to the borrower.

Besides the hassle of completing the repairs, the other drawback of these loans is that they tend to come with an interest rate of up to 1% higher rates than the traditional FHA loan.  To get around this, borrowers can refinance the home after the repairs are complete.

Additional information on the 203(k) loan can be found on the FHA Website.

First, you need to understand the strange dynamics at work in a short sale. The seller still owns the property and is still the seller. However, the lender is really the one in the driver’s seat since they have to approve a deal that will result in them accepting less than a full payoff. The result is that the lender can’t do anything without the seller’s permission and the seller can’t do anything without the lender’s permission. And the lender may have all sorts of very particular rules about what they will and will not permit in a short sale. For example, they don’t want the seller getting a single dime out of the transaction because if there was a dime to be had it should rightfully be theirs since they are the ones getting short changed. And, as you might expect, this is bureaucracy at its worst. You are often dealing with some low level administrative type who gets yelled at all day and is suffering from a false sense of importance. They give meaning to their life by saying “no” and there is no master list of stuff that they say “no” to. In fact, that’s what makes life so much fun for the low level bureaucrat. They get to surprise you with their “no” when you cross the line. Present a request to them with the wrong packaging and “NO!”. For instance, you might get a bank to give you a credit for an unforeseen repair or you might get them to approve a lower price but they might balk at giving you a credit for lost rent or a proration of rent for the current month. Therefore, if you want one thing you might need to call it another thing. When you are dealing with a short sale you are not in a rational world. The bureaucrat will gladly lose $100,000 to foreclosure rather than pass up the opportunity to exercise their pathetic authority.

It gets even more complicated as you consider the seller’s position in a short sale. You need to understand a basic concept: As the buyer in a short sale you are NOT doing the seller a huge favor. If anything, the seller may be doing you a favor. First, you are dealing with someone who is financially on the ropes. Odds are they have no money. They may be considering other alternatives to a short sale such as deed in lieu of foreclosure, letting it go to foreclosure, or even personal bankruptcy. If the property is not their primary residence, the amount of money the bank is going to lose on the deal becomes taxable income to the them (the seller). So, the seller may not care one way or the other. They may have moved into their mother’s basement or just checked out of the process, waiting for the worst roller coaster ride of their lives to end. They may not be getting their mail or returning anyone’s phone calls. So you are not going to get any money from the seller, they are not going to fix any problems, and there is no point in having your uncle, who is an attorney but not a real estate attorney, badger them with official looking correspondence that make demands on them.

Here is the bottom line. When you buy a short sale, you are shopping in the bargain bin. This is a closeout. Irregulars. Merchandise sold as is (for the most part). No returns.

Can you handle that? If so, you might pick up a great bargain.