What Is Creative Financing? 8 Of The Most Common Deal Types We See

As transaction coordinators, we see many deal types come through our business. One of the most amazing perks of being a TC is that we learn so much with each file that crosses our paths. Most of the business we do involves creative financing strategies. Every so often, we will work on a file that uses traditional financing methods, but that is few and far between. 

In the ever-evolving real estate landscape, innovative and flexible financial strategies have become key in unlocking opportunities and overcoming the traditional barriers that have come with rising interest rates. In this blog post, we will highlight several of the most common creative financing strategies we see regularly in our transaction coordination business, The TC Collective. 

What Is Creative Financing For Real Estate?

Creative financing in real estate refers to non-traditional, innovative methods employed to secure funding for property transactions. These methods often deviate from conventional mortgage structures. 

This approach empowers individuals and real estate investors to think beyond the confines of traditional loans, offering flexibility and adaptability in navigating the complexities of real estate transactions. Creative financing encompasses a spectrum of strategies unlike standard mortgages, including seller financing, lease options, subject-to-financing, and various forms of alternative lending. 

Creative financing recognizes that one size does not fit all in real estate and provides tools to tailor financial solutions to specific needs, overcome challenges such as credit limitations, and seize opportunities in competitive markets, ultimately reshaping the landscape of real estate transactions. Not only does creative financing help the home buyer, but it can also greatly benefit a property owner. 

Traditional financing options in this market currently require home buyers to pay extremely high-interest rates. Because of this, many buyers are unable to qualify with a conventional financial institution due to the high payments resulting from the interest rates. The creative financing option makes it so buyers don’t have to use traditional lenders, allowing them to work out a deal with the seller that will benefit both parties. 

The Most Popular Creative Financing Strategies We See As Real Estate Investors And Transaction Coordinators

Remember! Although creative financing options are a great way to grow a real estate portfolio, they are not just for real estate investing. Homestead buyers can benefit from creative financing techniques as well. 

Here are some of the most popular creative financing methods: 

Seller Financing or Seller Carry

Seller financing requires no conventional lender! The seller must own the property free and clear of any debt in the seller financing scenario. We consider this creative financing method to be the creme de la creme of real estate financing options. 

The seller of the real estate deal finances the entire real estate acquisition for the buyer. Just like a traditional mortgage, the new property owner makes monthly payments to the seller rather than a bank. 

Terms are laid out for the loan, payments are set up for the loan balance, and the seller is protected through a promissory note and a deed of trust or mortgage. If the buyer doesn’t pay back the seller financing loan, the house goes back to the original seller. 

The seller financing option benefits the seller because they don’t have to pay capital gains tax all at once, and they make additional revenue on the property by charging interest on the loan to the buyer. The method benefits the buyer because they don’t have to get a mortgage loan through traditional lenders, and the interest rates charged through owner financing are going to be less than through a bank.

Subject To 

“Subject-to” financing, short for “subject to existing financing,” is a creative real estate financing strategy where a buyer acquires a property while leaving the seller’s existing mortgage in place. In this arrangement, the buyer takes ownership of the property “subject to” the existing mortgage. The deed transfers to the buyer’s name; however, the debt or mortgage loan stays in the seller’s name. 

Here’s how subject-to financing typically works:

1. Existing Mortgage: The seller has an existing mortgage on the property, and the terms and conditions of this mortgage remain unchanged. The buyer does not take out a new mortgage but instead agrees to take over the property subject to the existing financing.
2. Ownership Transfer: The buyer and seller enter into an agreement, and the property title is transferred to the buyer. However, the original mortgage stays in the seller’s name.
3. Responsibility for Payments: While the existing mortgage remains in the seller’s name, the buyer is responsible for making the mortgage payments. It’s crucial for the buyer to uphold the terms of the existing mortgage to prevent any issues with the lender.
4. Equity and Benefits: The buyer gains ownership of the property and benefits from any appreciation in its value. They may also enjoy the tax advantages of homeownership. However, the seller retains the mortgage liability.
5. Risks and Considerations: Subject-to financing comes with risks. If the buyer fails to make mortgage payments, it could negatively impact the seller’s credit. Additionally, due-on-sale clauses in mortgages allow lenders to call the entire loan amount due if the property ownership changes, although in practice, lenders may not always exercise this right.
6. Exit Strategies: Buyers utilizing subject-to financing often have exit strategies in place. This may involve refinancing the property in their name or selling it before the original mortgage term concludes.

Subject-to financing is often employed when a seller is motivated to sell quickly, and the existing mortgage terms are favorable. It can be an attractive option for buyers with bad credit scores who may have difficulty qualifying for a new mortgage but can manage the existing payments. However, it requires careful consideration of legal and ethical aspects, and both parties should seek professional advice to navigate potential challenges and ensure a smooth transaction.

Agreement For Sale aka Executory Contract

An agreement for sale could also be referred to as an executory contract or a contract for deed. This type of sale agreement could be compared to an auto loan. When someone gets a loan to purchase an automobile, they take “equitable” title to the vehicle. They make payments over time until the full purchase price of the automobile is paid off. 

In real estate, the agreement for sale is very similar. An offer is made to the seller by the buyer to purchase the real estate for a given amount to be paid over time. When the total loan balance is paid in full, the buyer will assume full rights to the property. Until then, the deed stays in the original owners name, but the buyer retains what is called “equitable” title. The buyer controls the property, but makes payments to the owner of the property until the loan balance is paid in full. 

The seller retains legal ownership to the property and continues to pay their mortgage lender monthly payments until the agreement is paid in full by the buyer. 

Benefits of an agreement for sale

The agreement for sale can benefit the buyer who will struggle to qualify for traditional financing. Sellers can benefit from using an agreement for sale for several reasons. Maybe they have low equity in their property and will have to pay out of pocket to sell it traditionally, or if they are struggling to make their mortgage payments, this type of sale may help keep them from defaulting on their loan. These are just a few of the reasons this type of transaction could benefit both buyers and sellers.

Lease Option

A lease option is another way creative financing can be used to purchase real estate, and is similar to an investor renting out a rental property in the beginning phases of the contract. When utilizing this strategy, a buyer will use a purchase and sale agreement to write a contract that is like a “rent to own” scenario. The contract includes an option fee, which is paid to the seller by the renter. This fee is paid to compensate the seller for not allowing anyone else to purchase the property during the lease terms and as a chance for the renter to purchase the property at the end of the lease contract. 

Additionally, the renter pays an additional amount on top of their monthly rent payments that is held to be put towards a down payment when it’s time for the renter to purchase the property. If the renter fails to purchase the property at the end of their lease contract, they lose the lease option fee. 

Benefits of a lease option

A lease option can benefit a buyer if they don’t have great credit scores but see a property they would really like to purchase. They can make rent payments while they are working on improving their credit score. Part of the rent payments will help them save for a down payment. This option will benefit a seller because no matter what, they are making money on the property. They are collecting rent payments while the house is under the lease option contract. If the buyer cannot come up with financing at the end of the lease contract, the seller keeps the lease option fee, and can sell the property. 

Novation Agreement

A novation agreement, when used in the creative financing world is used as a tool for real estate investors or wholesalers to fix up a house owned by a seller, then profit off of the after repair value when the house is sold. 

Here is an example: 

If a seller wants $300,000 for their house that would sell for $400,000 after it is fixed up, they can enter into a novation agreement with an investor that details the terms necessary to fix up the house while the seller owns the home and continues to pay the mortgage. After the house is fixed up, the house is sold. The terms of how the profit is split can very but in many situations, the difference between the sale price of $400k, and the contract price of $300,000 would be split between the seller and the investor. 

These types of deals are risky, and legal advice is definitely recommended when entering novation agreement contracts. 

Private Money 

Private money lenders are common in the creative financing industry to help fund real estate deals for an investment property. Using other people’s money allows many investors to scale their portfolios much faster than if they were only using their own money.

Here are some ways a private money lender can help fund a real estate investment: 

• They can fund money needed to fix up a property
• They can fund money needed to pay of a different private money lender on a real estate transaction
• They can fund money for a down payment 

Private money lenders typically loan on deals lasting between 6-12 months and receive interest only payments during the term. However, there are short-term private lenders that fund short-term earnest money needs. 

In many situations, wholesalers or investors will need short-term funding for earnest money for their real estate investments. A real estate investor can bring on an earnest money lender to fund their earnest money. Typically this funding is for a very short timeframe, anywhere between 24 hours – 2 weeks. The short term private lenders will earn a very high fee for a return on their short term investment. 

Many private money lenders will use their self-directed IRA, or a line of credit, to produce the funds needed to loan money. The interest they receive on lending is higher than the interest they pay for their LOC, and a self-directed IRA has no interest. 

Hard Money Loans

A hard money lender is a lender that loans money on real estate investments. They don’t qualify the buyer based on their ability to repay the loan, but instead, they qualify the property on its value as collateral. Typically, hard money loans are more expensive than traditional loans, and the term length on these loans is much shorter than that of traditional mortgages. 

Hybrid Real Estate Sales

In a hybrid transaction, the seller owes money for their home to a traditional lender. Additionally, they have equity in the home. A buyer will purchase the home and take over the mortgage subject to, as discussed above. A second note will drawn up for the seller financing of the equity the seller has in the property. 

Essentially, this property will have two notes, the seller financing note and the mortgage taken subject to. The seller financing transaction will have its own payment structure and loan terms, which can be different than the subject to portion of the contract. 

Wrap Up

In conclusion, embracing creative financing options presents a dynamic approach to navigating the ever-evolving landscape of real estate. Whether overcoming credit hurdles, accessing competitive markets, or building a diverse investment portfolio, these financing strategies empower individuals to tailor solutions to their unique needs. 

The key lies in understanding the intricacies of each approach, conducting thorough due diligence, and recognizing the potential risks and rewards associated with both. In a world where adaptability is paramount, the integration of creative financing serves as a catalyst for success in the pursuit of real estate goals.