What Lenders Can Do To Help The Real Estate Transaction

Date: October 26, 2023
Subject: The Strategic Role of Lenders in Facilitating Transactions Through Creative Financing

1. Introduction: The “Why” of Creative Financing

The real estate market is fundamentally driven by affordability. As Gary Keller aptly states, “Affordability is the juice that makes the market go or stop.” In a shifting market characterized by rising interest rates and economic uncertainty, affordability tightens, causing deals to stall and inventory to stagnate.

It is crucial to understand that creative financing is not about dubious or risky schemes. Instead, it is a disciplined process of expanding the options beyond traditional 30-year fixed-rate mortgages to create legally sound, structured solutions that benefit all parties involved. This process is built on a three-part foundation:

1. Understand the Motives: What does each party (buyer, seller, lender) ultimately want to achieve?

2. Assess the Capabilities: What financial or non-financial resources can each party bring to the table?

3. Combine Creatively: How can these motives and capabilities be woven together to structure a successful transaction?

This report focuses on the pivotal role lenders play in this process, outlining the specific tools and strategies at their disposal to keep the market moving.

2. The Lender’s Motive and Capacity for Flexibility

A lender’s primary motive is to issue a profitable loan with a high probability of repayment. They operate within a strict framework of federal regulations and investor guidelines. However, within these boundaries, lenders possess a suite of powerful tools to help qualified buyers overcome common hurdles. A proactive and knowledgeable loan officer is a critical asset in a challenging market.

3. Creative Financing Options Available to Lenders

Lenders can actively facilitate deals through the following strategies:

A. Mortgage Buydowns
A buydown is a method of lowering the borrower’s interest rate, and consequently their monthly payment, for a period of time or for the life of the loan. The cost is typically covered by a third party, such as the seller or builder.

• Temporary Buydown (e.g., 2-1 Buydown): This is a highly effective tool for easing a buyer into homeownership.

  • How it works: The interest rate is reduced by 2% in the first year and 1% in the second year before settling at the original note rate for the remainder of the loan.

  • Benefit: It significantly lowers the initial payments, making the home more affordable upfront. The funds for the payment reduction are held in an escrow account, guaranteeing the lender’s payments.

  • Funding: The cost is often paid by the seller as a sales concession, making the property more attractive to potential buyers.

• Permanent Buydown (Buying Down Points):

  • How it works: The borrower (or a third party) pays “discount points” at closing—a percentage of the loan amount—to permanently secure a lower interest rate for the entire loan term.

  • Benefit: This provides long-term payment stability and savings, improving the buyer’s debt-to-income (DTI) ratio and overall loan affordability.

B. Portfolio Lending
While most loans are sold on the secondary market to Fannie Mae and Freddie Mac, some lenders (particularly local banks and credit unions) originate portfolio loans. These are loans they intend to hold in their own investment portfolio.

• Key Advantage: Because the lender is not bound by the strict “one-size-fits-all” guidelines of the secondary market, they have greater flexibility in their underwriting.

• Application: This can be ideal for well-qualified buyers with unique situations, such as those with non-traditional income, high assets but lower income, or properties that don’t fit conforming standards.

C. Flexible Underwriting (Within Limits)
A skilled loan officer can creatively structure a loan application to best present a buyer’s financial strength.

• Income Calculation: They can expertly calculate variable income, bonuses, or self-employment income to maximize the qualifying amount.

• Asset Management: They can advise on how to properly document and structure unique assets or large deposits to meet guidelines.

• Guideline Interpretation: Knowledge of the nuances within underwriting guidelines allows them to find pathways to approval that less experienced officers might miss.

4. Conclusion: The Power of Combination

The true art of creative financing lies not in using these tools in isolation, but in combining them to solve complex transactional challenges. Lenders are essential partners in this orchestration, providing the approval and framework for multi-faceted solutions.

Illustrative Example: A Combined Creative Deal

• The Problem: A qualified buyer lacks the full 10% down payment. A well-priced home is stagnating on the market due to high interest rates. The seller is motivated but needs a specific amount of cash at closing.

• The Creative Solution:

  1. The Buyer’s Contribution: The buyer uses a documented family gift from a parent to cover 5% of the down payment.

  2. The Seller’s Contribution: The seller agrees to carry a second mortgage (seller financing) for the other 5% of the down payment. Additionally, the seller pays for a 2-1 temporary buydown on the buyer’s new first mortgage.

  3. The Lender’s Role: The lender approves the primary loan with the secondary financing from the seller, underwrites the gift funds, and facilitates the setup and administration of the 2-1 buydown.

• The Win-Win-Win Outcome:

  • Buyer Wins: Gets into the home with less cash down and lower initial payments.

  • Seller Wins: Sells the property and earns interest on the second mortgage.

  • Lender Wins: Issues a new, well-structured first mortgage to a qualified borrower.

By embracing and proactively offering these creative strategies, lenders transform from simple gatekeepers into vital transaction engineers, driving market velocity and building lasting client relationships in any market condition.