'right of first refusal' as a real estate tool
May 9, 2014 2:28 PM   Subscribe

This question is following up on one I posted almost a year ago, trying to arrange sale of house to tenants who could not qualify for a bank loan (a resounding NO to self-financing and promissory note). If at all viable, I will follow up with an attorney; otherwise I will let it go. Here's the idea: They can now qualify for a $130K loan. The house is zestimated at $170K. What about selling them a right of first refusal for $40K to buy the house at $130K? They would pay me up front for the right and for my promise to make the house available within x time for them to exercise that right. They would of course still have to come up with a down payment for the bank/mortgagor, but I think it's more their credit than their cash flow that has been a problem in the past. Even as I type this I'm imagining Murphy's Law kicking in, but seems riskier for them (buyers) than for me.
posted by mmiddle to Home & Garden (14 answers total) 1 user marked this as a favorite
it's a whole lot riskier for them than it is for you. what you are describing is called an option, and depending on the term, 40k is a lot to pay for an option that depends on the goodwill of a bank for them to exercise. if the loan doesn't go through, is the 40k nonrefundable? ouch. there may also be different tax treatment of the 40k if it isn't part of the purchase price, so ask your tax guy/gal.
posted by bruce at 2:36 PM on May 9, 2014

Before you do anything else, I would get the house appraised, or at least get a broker price opinion from a real estate agent with experience in your area. Zillow themselves say their Zestimates only have a 70% confidence interval. In other words, you house might be worth $140,000 to $200,000 in reality. Giving them a call option and hoping they can come up with $15k is a lot different than giving them an option and hoping they can come up with $60k.
posted by Diablevert at 2:38 PM on May 9, 2014

Is this their idea, or yours? I'm asking because they're the sort of people living in a situation where the most they can qualify for on a mortgage is $130k, and I certainly know lots of people in that sort of income/credit range, and I'm having trouble imagining a situation in which someone like that could even come up with $40k cash without doing something irresponsible like raiding retirement accounts. Certainly not for anything with a significant risk factor attached. They, at least, would be much smarter to go off and just buy a house that's actually within their means.
posted by Sequence at 2:39 PM on May 9, 2014 [2 favorites]

Someone should get a real appraisal. Assuming the $170k number checks out, as you suggested, this is waaaay more risk for them than it is for you. Frankly, I don't know why they would agree to it. I've known people to pay up to $10k for options on houses before, but that was on a $1m+ house.
posted by craven_morhead at 2:41 PM on May 9, 2014

The last two appraisals I paid for cost about $400. That's not much money to get a lot of information before digging deeper into your options.
posted by Dip Flash at 3:03 PM on May 9, 2014

What's the motivation here? Are you trying to help them out? Because helping people buy a house which they cannot afford is not a kindness. Being house poor is misery.

If they had $40K lying around they could just use that for a downpayment and get the mortgage to the correct amount. If they hand you $40K and then can't get a loan, then you're in a real pinch. You could give the money back or you could take $40K off people you know couldn't afford it.

They can't afford this house. There's no shame in that. They need to do a few more years of saving/credit building/whatever.
posted by 26.2 at 3:22 PM on May 9, 2014 [3 favorites]

The main factor here is that they love, love, love the house and want to stay there forever, etc. they never ever want to live anywhere else. I would definitely refund their option $ if they didn't get the loan, but the bank has encouraged them. They make decent money but one has always under reported her income, and the other has never paid his taxes. They have a small child, and I would like to sell to them if possible. After talking to the bank, she called me to say that her mom had asked 'if I couldn't do something for them.' (Like maybe take a $40K loss??). The other thing is, I would love to sell the house, but it's in Memphis, and I have had mind-boggling bad experiences with realtors there, even when I lived there. Good suggestion, to get a certified appraisal, though it seems that appraisers for underwriters always come in at way below what comps are selling for.
posted by mmiddle at 5:05 PM on May 9, 2014

yes, you can do something for them, it's called owner financing, and as long as you have a sufficient equity cushion (and 40k on a 170k house is pretty good) it's considered reasonably safe by real estate professionals. i like 26.2's answer. have them make you a straight-up purchase offer, no option or right of first refusal, 40k down and you carry back a 130k first t.d. of course, get an appraisal first as the others have said. i would do a deal like that, i would not do a deal where i either had to refund 40k, or screw people i liked out of this amount.
posted by bruce at 5:34 PM on May 9, 2014 [1 favorite]

Sorry, but how does "carry back" work? Who would have title, and responsibility for repairs? How does the owner/lender avoid risk? Thanks for your thoughts; this is not my area.
posted by mmiddle at 6:00 PM on May 9, 2014

Okay, thanks for all these thoughts - googling for my answer, owner financing seems to be best where the seller owns it free and clear without a mortgage - otherwise there is the risk of "due on sale" foreclosure by seller's mortgagor, and in any case any default(s) by buyers would force seller to start foreclosure proceedings. Not something I could deal with.
posted by mmiddle at 6:20 PM on May 9, 2014

I have seen this done as the house is sold with the tenants arranging the $130 mortgage. Then a second mortgage is registered against the property as $40 with you as payable and a shorter term (and higher interest rate). The hope is they will refinance in a few years and pay you off entirely and just have one larger mortgage payment. They have the title but the mortgage allows you rights (such as foreclosure) if they don't pay your monthly second mortgage payment. Would the $130 pay off your current mortgage? If not, you have to take into account your increased costs in financing.

Can they pay you an extra thousand (or better yet two thousand) a month for the next four (or two) years to be the downpayment as a rent to own deal? After you have your forty thousand they can get the $130 mortgage (assuming the price of the house hasn't risen).
posted by saucysault at 6:26 PM on May 9, 2014

"and in any case any default(s) by buyers would force seller to start foreclosure proceedings. Not something I could deal with."

i respect, but disagree with this moral position. if they get a bank loan and they default, foreclosure will ensue and you have merely delegated your moral agency to the bank. i'm trying to help you and your tenants, from my perspective as a former california real estate broker in the early '90s but your responses aren't making it easier.

"carry back" means you're the bank, and as long as you have a sufficient equity cushion, it's fine. you route the transaction through a title company and structure it so you have impounds for taxes and insurance, just like a bank. your original question exhibited an irrational prejudice against owner financing, which i am doing the best i can to dispel.

you didn't say how much you owe on this property. yes, due on sale is a critical consideration. can you do a wraparound mortgage?

why don't you and the tenants sit down with a local pro and discuss your options? i bet it could be done fairly, but i am despairing that i and the other commenters can do this remotely.
posted by bruce at 7:09 PM on May 9, 2014

Thanks, Bruce, I do appreciate your effort; not sure what you mean re 'moral position.' I owe $113k. I don't live nearby, and I live paycheck to paycheck so really cannot afford any risk of loss, much as I would like to help them. I do like saucysault's suggestion of rent to own until my equity is paid out, though
posted by mmiddle at 9:27 PM on May 9, 2014

They make decent money but one has always under reported her income, and the other has never paid his taxes.

These are not good things for you to take a risk on financing with. Fed tax liens are not superior to the mortgage (afaik, ianal, ianyl), but the IRS can do a lot to get paid. You do not describe yourself as having the cushon to deal with the disrupted cash flow if, for any reason, these people can't pay. If they make such good money, they can save it for a few years while they rent.
posted by Ms Vegetable at 6:46 AM on May 10, 2014 [1 favorite]

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