All of the above strategies are fine when the economy is inflating, but what about when interest rates and equities are deflating? Over the past several years or so, we've seen falling market interest rates, leaving many would-be sellers with existing high interest rate loans stranded high and dry with no buyers willing to take over their payments.
One way to jump-start sales in a slow market is to offer low interest rate financing with a low down payment and low payments. But, how can a property with an old 14% loan be sold even in a 10% market?
We mustn't overlook the fact that the AITD can also be used to LOWER interest rates when the current rate is below that prevailing at the time of the original loan. In such a situation the Seller would in effect be subsidizing the interest rate. In the reverse of the above illustration, he or she would be PAYING a 5% differential in order to make the property attractive to the Buyer at lower interest rates. Here's an example:
Over the past 15 years or so, mortgage interest rates have fluctuated over a range from as low as 4.5% to as high as 22.5%. A high interest rate loan makes a property virtually unsalable when rates drop. At such times, an opportunistic buyer has a chance to negotiate lower overall prices and/or softer terms from anxious sellers. But then, he must then find a way to motivate a subsequent buyer to purchase the property at full retail market value from him.
When the former 'buyer' wants to re-sell a property on which there already exists one or more mortgages, he can offer the property at a low down payment and 'wrap' all of the existing higher rate fixed interest rate loans with a variable rate indexed loan that starts at the lower current market rates. Thus, he'll avoid being trapped in fixed rate terms if high interest rates return during the loan term.
This enables him to be a sort of Monday morning quarterback; getting all the benefits of prior lenders fixed rate financing while being able to index his own loan at a variable rate to hedge against inflation wiping out the purchasing power of his loan repayment.
To hedge against future falling interest rates, the lender can make his wrap 'callable' to motivate the borrower to refinance the property. Since only the lender will know when he intends to call the loan, this will give him plenty of opportunity to negotiate a discount for an early payoff with any senior lien holders whose loans are wrapped by the buyer's loan.
Let's use some numbers. Suppose a house with a remaining mortgage loan value of $100,000 were financed with a 14% loan that had originally been $150,000. P&I loan payments are $1777 per month. The house itself has a fair market value of $300,000 but the market is weakening. Current interest rates are 9%. If the house were sold at $300,000 with 10% down and 9% interest amortized over 30 years on remaining $270,000 loan balance, the payments, including both principle and interest, would be $2,171.55 per month.
The seller might offer to sell the house on an installment contract for $299,950 after a $15,000 down payment. He agrees to finance the $284,950 balance for 3 years at 8.75% interest-only on a full recourse loan. This will require mortgage payments of $2077.76. Here's how each parties respective payments look over the 3 years.:
| Seller | Buyer | ||
| Existing Loan Amount | $100,000 | Contract | $284,950 |
| Cash Down Pmt Rec'd | $15,000 | Paid | $15,000 |
| 3 Year's Total Payments | $63,972 | $74,799 | |
| Total 3 Year Net Cost | $32,481 | $89,799 |
By under-wrapping the existing loan interest rate reducing the down payment to only 5% rather than 10%, he attracts buyers and makes his sale. Each month he pays the underlying loan out of the payments made on his wrap around contract. In three years, the buyer can refinance the property and pay him off, or the seller can renegotiate the loan and increase the interest rates. In the meantime, the seller has gotten rid of his white elephant.
What about the buyer? He hasn't done badly. He has saved $15,000 in down-payment cash; plus, he saves a little on his fully deductible mortgage payments over the next 3 years when contrasted with payments on a 30 year amortizing loan.
As interest rates continue to drop, he'll be able to refinance the house at lower costs at the end of the three year period, or sell the house to someone else who will refinance it. Meanwhile, the seller, for the next 36 months, will be realizing about $300 per month positive cash flow income rather than $1777 in negative cash flow payments.
