The American Education Institute

USE DISCOUNTED BONDS.

This and the following three methods are further derivations based on seller financing.  Using discounted bonds, the first of the three, is a relatively simple method, but it also has probably the greatest potential.

Most likely, some collateral will usually be required whenever a seller helps finance a property.  Usually, of course, this collateral amounts to the property itself.  Usually, of course, this collateral amounts to the property itself.  But it’s also a fact that physical property deteriorates, required upkeep, and quite possibly will fall into some disrepair by the time a seller would be forced to foreclose should you ever default on his mortgage.  This is why you should try offering to such a seller a mortgage secured not by real estate but by good quality bonds.

You can easily find such bonds listed in the daily papers.  In the Wall Street Journal, for instance, private corporate bonds (sometimes called “New Your Exchange Bonds”) and U.S. Government bonds are listed every day.  You need to contact a stockbroker regarding tax-free bonds, but these are the kinds of securities most attractive to potential lenders and mortgage makers.  City, state, and county revenue bonds are usually solid, zero-interest, and tax-free bonds that come due usually within ten years.  Such bonds are not exactly interest-free (because then they would not be very much of an investment, would they?)  but they pay their dividends at maturity.  In other words, when you buy such a bond now for between $500 to $700, after it matures in ten years it may well be worth $1,000 (depending upon interest rates at the time you bought it).  And remember, there’s no tax liability to you (or the seller) based on the amount of these earnings.

Here is an example where you can use such bonds in lieu of collateral secured by real estate.  Suppose a seller has a four-family apartment building for sale at a price of $100,000.  A single mortgage in the amount of $25,000 already exists on the property, which means that this seller has attained $75,000 in equity.  He is requiring a cash down payment of $10,000, but he’s willing to accept $65,000 in the form of a second mortgage payable in ten years.  You’ll also have to satisfy the existing $25,000 mortgage to make this deal go through.

Now you can ask this seller if he’ll accept good quality bonds as security for the %65,000 loan in lieu of a second mortgage.  If he will accept this creative type of financing, you then offer to buy the building with the $10,000 cash due in 90 days along with a $65,000 note secured with these bonds.  You must also ask the seller to actually deed the property to you with its $75,000 equity secured by yet another property which is already owned by you or a friend or partner of yours.  As may well be necessary, you can protect this seller’s interest by issuing back to him a “quit claim deed” (with a title company holding the deed in escrow) that covers the property he’s selling to you.

This maneuvering will then make you the owner, and you can proceed to satisfy the remaining financing requirements.  Now you go about the task of securing you own mortgage on the property in the needed amount of $75,000 (which should be easy because you now have that much equity).  When you obtain this new mortgage, simply disburse the money as follows:  $25,000 to pay off that existing first mortgage, $35,000 to buy the necessary $65,000 in bonds that mature in nine or ten years, $10,000 in cash goes to the seller at the closing (within 90 days, remember), and the remaining $5,000 can go in your pocket.

What has happened?  The existing mortgage has been paid off.  The seller has obtained a $65,000 note for the balance which will be payable in ten years with the redemption of good quality bonds which will indeed be worth that much at that time.  The original mortgagor, the seller, and the bond issues are all satisfied.  Now you own a $100,000 income-producing property with a $75,000 mortgage which already has produced for you $25,000 in equity.  And, in addition to all of that, you now have $5,000 more yourself which you didn’t have before you started negotiating this deal.  Creative financing at its very best!  You might even think of this as 105% financing!  is that possible?

It certainly is possible, but there are several things you need to watch out for.  The method really works best when there is, quite specifically, a low existing mortgage on a highly valuable property.  Also, not all good quality bonds are tax-free.  It the bonds you’ll be using are taxable, it’s the seller who will incur the tax liability in the form of an annual gain as those bonds increase each year in value, and you’re going to have to make sure the seller knows and agrees to this.  But you both can still avoid this taxation by using what’s called “zero-coupon municipal bonds.”  In the example cited above, the bonds used to produce the $65,000 at maturity are in fact zero-coupon municipal bonds.  So the seller therefore has no annual tax obligation because those bonds effectively don’t increase at all in value until they mature.

Additionally, you are basically asking the seller to hold a $65,000 mortgage at zero interest.  (Remember, those bonds earn nothing until after their term expires, or matures.)  But this might be asking too much, so if necessary you can sweeten the deal for the seller by offering to pay him a fair rate of interest annually yourself.  (Remember, too, that what becomes available at maturity is not interest; it’s principal only.  You therefore might well have to pay yearly interest based on that $65,000 principal to your mortgagor himself — the seller.)  But, if you budget yourself well paying annual interest like this should no be that much of a problem.  You would have to pay it anyway to a traditional mortgage company.  You also have you $5,000 “extra” at closing.  And you will also have rental income every month, certainly throughout the term of this discounted-bonds-backed “mortgage.”

Another thing to remember is that you are not double-dealing here.  None of this is “below board” or illegal, and you are not trying to deceive anyone — especially not the seller.  He mush know that your discounted bonds are today worth just $35,000, but also that they will be worth what his own government tells him they’ll be worth when the government says they’ll mature.  This is faith in the American system, is it not?  Hence, the seller should not worry.  His actual only risk is lack of interest, but if you agree to pay that too, he should then have no more risk than any other mortgage lender takes in “betting” on a sure thing.

One final thought concerns actually assuaging the seller’s risk by backing your guaranteed payments of interest through, perhaps, another mortgage taken out on another property you already own.  Or, you could offer the seller several years worth of interest payments in advance.  (Your initial $5,000 paid to him in this way will do a lot to calm his fears.)  Or you might also buy additional zero-interest bonds to cover the full amount of whatever the total comes to for this annual interest at the time all such mortgage terms and bond mature dates come due.

METHOD NUMBER 18 IN BRIEF

What it is designed to do:

Make  a mortgage using only discounted bonds as security

What you need:

• Fairly low existing mortgage on comparatively valuable property
• Equitable property that you or a partner already owns

What your terms are:

1.  Income property asking price                          $100,000

2.  Present mortgage                                                  $  25,000

3.  Equity to seller                                                       $  75,000

4.  Cash down payment                                             $  10,000

5.  Bonds-backed mortgage                                     $  65,000

How you proceed:

1.  Make the offer to a seller’s mortgage backed by good quality bonds redeemable for the full mortgage amount at bond maturity.

2.  Agree to pay required cash down payment in 90 days and secure the $65,000 balance to seller with good quality bonds.

3.  The seller mush agree to deed the property to you, securing his equity with another property you or a partner owns; or otherwise hold in escrow a “quit claim deed” that repossesses the property should you default.

4.  Use you property deed to secure your own $75,000 mortgage.  With these funds:  pay off the present $25,000 mortgage; pay $35,000 to buy $65,000 worth of bonds;  pay $10,000 down payment;  pocket the remaining $5,000.

What the seller can expect:

• Seller obtains his required cash down payment.
• Seller’s own mortgage is paid off.
• Seller is guaranteed full payment of his selling price balance within ten years.

What you the buyer can expect:

• You have instant equity in an income-producing property.
• You have obtained 100% (possibly even 105%) financing, pocketing extra cash at closing.

Dr. Eric T. Martin / 100% Financing When Buying Real Estate / 2-26-10