Creative Financing

Creative Financing

Ken DeLeon and Michael RepkaApril 10, 2014
Palo Alto Daily Post

Many foreign investors, attracted by the Silicon Valley’s appreciating land value paired with its excellent schools, have started pouring their money into this high-end real estate market. As a result, today’s market is brimming with all-cash and non-contingent offers. This influx of cash-rich buyers have forced traditional buyers (buyers who put down 20% deposit) to become creative in order to be competitive. Notably, homes sold in cities like Palo Alto, Los Altos, and Mountain View regularly experience multiple offers, and victorious offers are often all-cash, non-contingent, and usually the highest price. Buyers looking to purchase homes in these areas have no choice but to jump in on the all-cash, non-contingent offer bandwagon. What should buyers in this market do if they do not have the necessary cash?  This article will discuss several creative ways to make the buyers’ offer more attractive to sellers. 

Liquidate Other Investments

Buyers can liquidate other investments and use that cash to make a significant down payment. After close of escrow, buyers can refinance and pull the cash out of the home to recapitalize the original investment. A critical factor in using this strategy is making sure to choose a loan program that does not have a pre-payment penalty or charges a higher rate for the cash-out refinance loan. Keep in mind that the sale of these assets may trigger capital gains tax and the loan must be in place within 90 days of closing to qualify for the IRS’s mortgage interest deductions, if applicable.

Asset Depletion Loan

There are innovative loan programs that cater to the needs of high net-worth individuals. For individuals who do not have a “job” in the traditional sense, but generate income from substantial assets or savings, an asset-based loan or asset depletion loan is ideal. For example, these loans apply to individuals who do not have documentable monthly income, but do have a substantial savings account that could be used as a down payment, with significant assets remaining after the down payment. The loan is 5/1 adjustable rate mortgage, and the loan value can be 65% to 80% of the assets’ value. Loan amounts can range from $250,000 to $4 million. Generally, this program is ideal for high-tech entrepreneurs that have taken significant time off from work. This loan program allows them to side step the usual requirement of a documented two-year work history.

Equity Sharing

Another innovative loan program involves equity sharing, ideal for those wanting to minimize the outflow of cash at the time of purchase and avoid private mortgage insurance when making monthly payments. In this structure, the equity sharing lender puts 10% down, and the buyer puts in the other 10%. After closing, the buyer makes monthly payments on the first mortgage (the mortgage obtained on the 80% purchase price) during the time they own the home. The equity sharing lender of the 10% down shares in the appreciation of the property, since the 10% down payment contributed is considered an investment, not a traditional loan. Unique to this structure is that no interest is charged nor monthly payments required on the 10% from the investor. The transaction fee of 2% of the down payment applies at the close of the home sale.

Conclusion

Creative financing has evolved significantly over the last five years. From what was merely a down payment stop-gap measure used by home homebuyers at a lower price point, it is now a niched loan product allowing buyers to maximize cash on hand, preserve assets, and leverage equity share options while winning the bid for that perfect home. So, if you wish to stay afloat in the Silicon Valley market’s home buying market, make sure to be creative.