Discounted bonds are ranked as one of the best real estate creative financing techniques do to that it is so simple and yet has such great potential.
If a seller is willing to assist in financing the property, some collateral will certainly be required. Generally, this takes the form of the real estate that you are buying. But deep down, I am convinced that most sellers would be more comfortable having their notes secured by good quality bonds.
Look at the bond quotations in any newspaper or call a stock broker. Find a good tax-free zero interest bond, like a city or county revenue bond, that will be due in nine or ten years. You will probably have to pay between $500 and $600 for one of these bonds, but when it becomes due and payable at maturity in nine or ten years, it will be no tax liability for the seller or you.
This technique works best when you have a relatively low mortgage to property value ratio. Look at the following example: assume that a New York seller has a four family property on the market for $100,000. The existing mortgage on the property is $25,000, and the seller has $75,000 in equity. The down payment the seller needs at closing is $10,000 cash, and the seller is willing to accept a $65,000 second mortgage due in ten years.
Ask the seller if good quality bonds securing the $65,000 note would be better that a second mortgage on real estate. Some sellers will agree to the bonds. You then offer to buy the property with the $10,000 down payment due in 90 days and the $65,000 note secured by the bonds. Ask the seller with equity in another property, or perhaps a friend’s or partner’s property.
Once you are the owner, obtain a new $75,000 mortgage on the property. The proceeds from the $75,000 are used as follows: $25,000 to pay off the first mortgage, approximately $35,000 to buy the $65,000 worth of discounted bonds due in nine or ten years, $10,000 goes to the seller and you can put approximately $5,000 cash in your pocket.
What is the outcome of the purchase? The seller has received the $10,000 cash which was required and now has a $65,000 note secured by bonds which will be worth $65,000 when they mature. You now own a $100,000 property with a $75,000 mortgage and $25,000 in equity. In addition, you have put approximately $5,000 in your pocket.
While this technique is extremely creative and can work beautifully in many situations where there is a low mortgage on a property, several potential problems exist. First, under current tax law, if the bonds are taxable, the seller will have to recognize a gain annually as the bonds increase in value. Tell the seller this. In the example used, there is no tax liability because the bonds are tax free.
Second, unless the seller is willing to take zero interest on the note (the bonds securing the note are paying zero interest), you will have to make interest payments each year until the bonds mature. This need not present a problem as long as you budget properly. Do not forget, you will receive cash at the closing.
To avoid the yearly recognition of taxable gain, you may want to use a zero coupon municipal bond. Check your local securities dealer for some suggestions.
It should be clearly understood that we are not attempting to deal in an underhanded way or to fool the seller. Everything should be spelled out and understandable to the seller; while the bonds are only worth approximately $35,000 today, they will be worth $65,000 at the time the seller has agreed to receive the money in ten years. The seller’s only risk of loss is the interest you have agreed to pay in the meantime. To overcome this, you might agree to secure the interest with a mortgage or another property you own. If you have the cash, you could prepay several years interest. You could even buy a second zero interest bond for that amount which could be used as security for the interest you have agreed to pay. Or, you might be able to negotiate zero interest so you would have no interest payment obligations. Be creative.
| Example Summary Technique #11 | |
| Using Discounted Bonds | |
| What You Need To Begin: | |
| Relatively low mortgage to property value ratio. | |
| Property with equity or a partner with equity in a property. | |
| Summary Of Terms: | |
| Four Family property | $100,000 |
| Existing mortgage | $ 25,000 |
| Seller’s equity | $ 75,000 |
| Required cash down payment | $ 10,000 |
| Mortgage from seller | $ 65,000 |
| Procedures: | |
| Ask the seller which is better, good quality bonds or a second mortgage. | |
| Offer the down payment due in 90 days and secure the balance with bonds. | |
| Ask the seller to deed the property to you and secure the seller’s equity with another property you own. | |
| Obtain a new mortgage for $75,000 and use it to pay off the first mortgage, buy the required bonds, pay the seller and the down payment, and keep the rest. | |
| Results: | |
| The $100,000 cash is received. | |
| The seller has bonds to secure the $65,000 note which is due in ten years. | |
| The buyer has equity in a property. | |
| Extra cash has been generated for the buyer. |
| Specific Situations to Apply Technique #11 Discounted Bonds |
| The Property |
| Property Offered Below Market |
| Low Mortgage, High Seller Equity |
| Owned Free and Clear No Mortgages |
| The Buyer |
| No Cash at All |
| The Seller |
| Will Finance: Wants Short Payoff |
| Will Rent or Sell |
Discounted Bonds To Foreclosure Bargains