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California Real Estate Finance Bond, McKenzie, Fesler & Boone Ninth Edition. Chapter 14 Creative Financing Approaches. Objectives. After completing this chapter, you should be able to: Differentiate between traditional and creative financing techniques.

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california real estate finance bond mckenzie fesler boone ninth edition

California Real Estate FinanceBond, McKenzie, Fesler & BooneNinth Edition

Chapter 14

Creative Financing Approaches


After completing this chapter, you should be able to:

Differentiate between traditional and creative financing techniques.

Identify at least five ways in which real estate can be financed through ways other than the traditional methods.

Contrast the all-inclusive trust deed to the installment Contract of Sale, citing at least three differences.

Apply the formula to calculate blended interest rates.

Name the instruments required to close a sale using the creative techniques presented in this chapter.

List at least six items that must be disclosed under the Creative Financing Disclosure Act.


Secondary Financing Techniques

All-Inclusive Trust Deed (AITD)

Installment Sales Contract

Lender Participations


Open-End Trust Deed

Commercial Loan

Stock Equity/Pledged Asset Loans

Blended-Rate Loans

Creative Financing Disclosure Act

Imputed Interest

secondary financing techniques
Secondary Financing Techniques

Second Trust Deeds carried by seller

Referred to as “gap loans”

Carried back by seller

Helps buyer to purchase home

Due in shorter time frame than first trust deed

Buyer may renegotiate the second

Secure a new loan to pay seller

Refinance the entire loan

In mid-2009 Fannie Mae and Freddie Mac eliminated seconds

collateralizing junior loans
Collateralizing Junior Loans
  • Use seller-carried note and second dead of trust as an asset
  • They are pledged at collateral for a loan through
    • Private parties
    • Mortgage brokers
    • Commercial banks
  • At a discounted value
  • Seller receives cash
seller sells the second loan
Seller Sells the Second Loan
  • Instant cash
  • Deep discount
  • Who buys?
    • Escrow companies
    • Loan brokers
    • Holders of maturing junior trust deed loans
broker participation
Broker Participation

Broker becomes a lender for part of the equity

Break note into two parts

Assignment of seller’s note and trust dead for the portion of the broker’s interest

In default, broker can foreclose

combination or split junior liens
Combination or “Split” Junior Liens

Create second and third trust deeds

Can sell a smaller second easier

all inclusive trust deed aitd aka wrap around
All-Inclusive Trust Deed (AITD) (aka wrap-around)

Junior deed of trust to original loan

Seller will pay off loans from monies received from buyer

Used when

In lieu of installment sales contract

When existing loan cannot be paid off until later date

Buyer wants income tax benefits

Seller has overpriced property

Low down payment

Low interest existing loan

Seller firm on price but not terms

Buyer cannot qualify

Heavy prepayment penalties

When severe money crunch hits mortgage market

Cannot be used to avoid due on sale clause

characteristics and limitations to aitds
Characteristics and Limitations to AITDs

Can increase the seller’s rate of return

It is a purchase money transaction, subject to encumbrances, to which it is subordinate

The buyer become a trustor-grantee

The seller becomes a beneficiary-grantor

Subject to California’s antideficiency statutes so buyer-trustor is held harmless should foreclosure occur

Legal title is conveyed by grant deed and is insurable by title insurance

In event of default and foreclosure, the seller-beneficiary follows normal foreclosure procedures

all inclusive trust deed
All-Inclusive Trust Deed

Equity payoff

Buyer takes over prior loans after seller’s equity has been paid off

Full payoff

Buyer continues to pay until entire balance is paid

all inclusive trust deed1
All-Inclusive Trust Deed

Benefits to seller

Only way to dispose when lock in clause

Broader market because seller is willing to carry back

No loan fees

Higher sales price

Defer recapture of equity

Retain favorable terms of first

Increase net yield

No interest rate limitations

Know immediately about default

Trustee’s sale is speedier

Income tax advantages

Similar to installment sale

all inclusive trust deed2
All-Inclusive Trust Deed

Benefits to buyer

Get property not qualified for

Larger property for same down payment

Only one monthly payment

Closing costs reduced

Extra long terms can be negotiated

No points

No prepayment penalties

Lower capital gain at resale

Grant deed at beginning, not end

all inclusive trust deed3
All-Inclusive Trust Deed

Precautions for sellers

What about impounds?

Timing of AITD payments compared to first mortgage

Limit another AITD upon resale by buyer (due-on-sale clause)

Reserve right to have buyer refinance at later date

Approve leases on income producing property

Precautions for buyers

What if seller defaults?

Request notice of default and notice of sale

Set up payments to cover any liens against seller

procedures in setting up aitd
Procedures in Setting Up AITD

Examine existing trust deed clauses

Due on sale



Ascertain outstanding balances, periodic payments and balloon provision

Who collects and disburses payments

Spell out default and foreclosure procedures

Get title insurance

Get insurance coverage

installment sales contract aka conditional sales contract or land contract
Installment Sales Contract (aka conditional sales contract or land contract)

Title remains with seller

Until contract is complete

Lawsuit is necessary for foreclosure

Significant income tax benefit to seller

Prorate capital gains over life of the note

Can be used for any real estate including vacant land

lender participations
Lender Participations

Participation in revenue of project

Equity participation

Charge one time fees or points

Profit Participation

Multiple lenders

sale leaseback aka purchase and lease back
Sale-Leaseback(aka purchase and lease-back)

Investor buys property

Develops land

Sells to major investor

Leases back property

Could be used for just land, just improvements, or both



Lease payments are tax deductible

Rent is lower than loan payments

Improvements may be tax deductible

Frees up capital

Long term leases not shown as long term liabilities

Cash today, payments later

Could buy back at later time


Higher yield than loan

Appreciation to lessor

In default can go after other lessee assets

Lease payments cover original investment and leave lessor with title

Lessee could pay for repairs, maintenance, insurance, utilities, taxes and operating expenses. (triple net lease or net-net-net)

Could do sale-leaseback with another party for same property



Long term contract

No participation in appreciation

Rent may exceed loan payments

Expiration of lease could lead to problems

Improvements may cost too much


Lease payments are taxable income

Rents could go below market

If default, must operate property

May not get depreciation deduction if only land lease

Capital is tied up

Only lessor, not creditor in case of seller insolvency

Did lessee develop property for special purpose?


Is repurchase option below market?

open end trust deed
Open-End Trust Deed

Add on to principal

Either until original loan amount

Or until fair market value

Not used too much due to seconds

commercial loan
Commercial Loan

Personal loan from bank

Borrowers of substance

Usually less than three years

Purchase real estate

Finance home improvements

Purchase a foreclosure, when cash is required

stock equity pledged asset loans
Stock Equity/Pledged Asset Loans

Marketable securities are used as collateral

blended rate loans
Blended-Rate Loans

Existing loan interest rate

Market interest rate on new loan

Somewhere in between

(Existing rate X Existing loan balance)

+ (Market rate X Net new money)

Blended yield = ________________________________

Total financing


Buyers receive below market rate

Borrower qualifies more easily

Cash proceeds are greater

Seller does not carry back as much paper

Lender increases yield on old loans

More creative

Could be combo with lender and seller

creative financing disclosure act
Creative Financing Disclosure Act

Description of terms of loan

Any other financing

Warning about negative amortization

When AITD, then who is responsible

Terms of balloon payments

Credit information about buyer

Warnings about seller’s role in case of buyer’s default

imputed interest
Imputed Interest

If project >$4,217,500, then interest rate >9% or applicable federal rate (AFR), whichever is lower

AFR is rate on federal securities with same maturity

Does not apply to seller carry back loans when buyer uses property as principal residence

Changes capital gain into ordinary income