First Time Buyer

An Intro to Some Basic Real Estate Transactions

Whether you are a real estate investor or a first-time home buyer, you will be required to negotiate and sign property contracts before closing any deal. Accordingly, you need to know the different types of real estate transactions or contracts that you might need to enter into.

Most people associate a conventional mortgage loan in a real estate transaction. However, there are alternative homeownership financing options if you want to buy a new home, but you cannot get your bank or lending institution to approve your mortgage loan.  Even in the absence of the conventional mortgage loan type of transaction, buyers and sellers can still enter various real estate transactions.

Real estate transactions play a significant role in real estate investing and general homeownership. Below are some common types of real estate transactions and alternatives to the traditional mortgage loan type of transaction that you can use to make informed decisions as a property investor or a potential homeowner.

Subject-to Transaction

A subject-to transaction is one of the various non-conventional forms of a real estate sale. A subject-to mortgage involves a buyer taking over the payment of the seller’s existing mortgage but with the loan staying in the name of the property seller. Essentially, the transaction is subject-to the existing form of financing.

Even though a subject-to transaction allows a buyer to take over the payment of the seller’s mortgage, it is usually without an official agreement with the mortgage lender. Typically, the lender is not aware of the payment agreement between the buyer and the seller. This means the buyer has no legal obligation to make the payments. However, the property risks foreclosure in case of default.

This type of real estate transaction is popular with real estate investors, where the investors buy property without credit and often with little cash. While it is common with investors, the subject-to transaction is also a viable alternative for regular homebuyers, especially with high interest rates.

One of the advantages of a subject-to real estate transaction is that it reduces the cost of purchasing a property. It eliminates closing costs, broker commissions, origination fees, and other costs associated with a conventional real estate transaction. This means increased profits for a real estate investor who intends to re-sell the property in the future.

A subject-to transaction also offers an easier and quicker way of buying property. Additionally, it allows buyers who would otherwise not qualify for the conventional mortgage financing or may not attract favorable interest on their loans to purchase real estate property. Essentially, taking over someone else’s mortgage loan may mean better terms and a favorable interest rate in the long term.

However, the subject-to transaction can also be a drawback as it puts buyers at risk, especially if the lender requires the seller to pay the loan in full.

Wrap Transaction

A wrap transaction, also known as a mortgage wrap, is a type of real estate transaction where the seller finances a property sale. This form of transaction is common where a property cannot pay off the current mortgage lien. Accordingly, the seller agrees to hold a second smaller lien while the existing mortgage lien is still in place.

Wrap transactions or wraparound mortgages are legal in Texas. They are primarily used where the buyer cannot secure the traditional form of property financing, either from a mortgage lender or a bank.

Typically, a conventional property sale involves a seller wishing to sell their home with an outstanding mortgage. In such a case, the buyer applies for a mortgage loan from their lending institution and pays a down payment to the seller once the loan is approved. The buyer’s bank or mortgage lender will then pay off the seller’s outstanding mortgage while paying the remainder to the seller.

Essentially, the seller’s outstanding mortgage is ultimately settled in such an arrangement, and the buyer now owns the property. A wrap transaction is slightly different. In a mortgage wrap, instead of applying for a mortgage loan, the buyer directly pays the seller a down payment and gives them a promissory note to settle the remainder of the property price at agreed dates.

The buyer now owns the property, subject to settling down the promissory note to the seller. However, unlike in a conventional mortgage loan type transaction, the seller’s original mortgage is still outstanding. Accordingly, the buyer makes monthly payments on his promissory note to the seller, and the seller pays their mortgage balance. Essentially, the buyer’s debt has wrapped around the seller’s outstanding mortgage.

Compared to a traditional property sale, wrap transactions are quicker to close. Generally, the seller does not need to go through the often slow process of applying for a loan from a lending institution before closing a wrap transaction.

Additionally, wrap transactions allow individuals who would otherwise not qualify for traditional mortgage financing to obtain finance and buy properties. A wrap transaction also allows both parties to negotiate the real estate transaction on their terms.

However, a wrap transaction also has some disadvantages, including the inherent risk of having two mortgages for the same property. Typically, it increases the risk of default and foreclosure. For instance, a default by the seller or original owner may lead to a foreclosure even where the current owner or the buyer has made their payments.

Owner Finance Transaction

While taking a mortgage is the most common form of financing a real estate investment, not everyone can meet the often strict requirements of a mortgage. Owner financing is one of the alternatives to taking a mortgage when buying a home. Typically, an owner finance transaction involves the property owner or seller financing the purchase, often at a higher interest rate.

Essentially, the buyer gets a ‘loan’ directly from the seller instead of going through a bank or a mortgage lender. The buyer finance the entire purchase price or a percentage of the price. Once both parties agree to the transaction terms, the buyer starts making monthly payments as per an agreed schedule. The owner finance transaction may also include the buyer making a lump-sum payment at the end of the loan arrangement.

An owner finance transaction has several advantages, including that it effectively simplifies the property sale and purchase process. It eliminates the need for a lender and related processes, including appraisal and loan approval. Typically, it allows for a faster and cheaper closing. It also allows the buyer to have a flexible down payment.

Like other non-conventional types of real estate transactions, owner finance transactions allow otherwise unqualified individuals to buy property.  And like a traditional mortgage transaction, an owner finance transaction involves the buyer making a down payment and paying the balance over an agreed period.

Lease Option Transaction

A lease option transaction is a real estate transaction that allows a renter to buy the rented property at the end of the rental period. The real estate agreement also prevents the property owner from selling the property to any other interested party. The renter must either exercise the purchase option or forfeit it at the end of the rental period or term.

Essentially, in a lease option transaction, the buyer pays for the right to buy the property later. A lease option agreement is also known as a lease with the option to purchase. A lease option is more flexible than a conventional lease-purchase agreement, including giving the renter the buy option.

Typically, the buyer or the renter and the seller have an upfront agreement on the property’s price. Since the agreed price is usually the property’s current market value, it allows the renter to buy the property in the future at today’s price. This is often beneficial to the renter considering increasing interest rates.

However, the arrangement typically involves the renter paying an upfront fee as part of the down payment. A lease option is common with people who are still building their credit and cannot get the traditional mortgage finance from banks and other lending institutions.

One of the downsides of lease option transactions is the trade-off for the property owner who forfeits the chance to sell the property at a potentially higher price. Consequently, property with lease options has higher rental rates where renters pay comparatively more rent. Essentially, the owner charges a premium in addition to the regular rental rate.

We can help

This is some basic information regarding common real estate transactions.  It serves as general explanations of each transaction.  Within each transaction, there are specific laws that must be followed.  If you have any questions about these type of transactions or the laws associated with these transactions, please do not hesitate to contact us at Zarazua Law, (210) 538-2786.