Alternative Financing When Mortgage Interest Rates Rise – Then and Now

When interest rates on mortgage loans climbed to historic levels in the 1980s, it was very hard for home buyers to sign on to a 16% mortgage loan. Even though it was pretty tough times, the real estate industry had tools to keep the market moving.

If a mortgage holder was a Colorado savings and loan, the interest rate on a qualifying loan assumption could only be increased by 1%. When interest rates were 16%, a seller might have a loan at 10% and it would only go to 11%. It seemed like such a deal then!

FHA and VA mortgage loan assumptions were a savior of the ‘80s. Unless the seller wanted replacement of eligibility (in VA cases) or replacement of liability (in FHA cases), a buyer could assume the loan with no rate increase and no qualifying. All you had to do was sign your name and come up with the difference between the purchase price and the loan amount. In many cases, the seller would be willing to carry a second mortgage for that difference. If a seller needed the cash instead of keeping the note, the seller could sell the note at a discount to an industrial bank or private investor. Wow, those were fun times!

The appreciation of real estate values in the ‘70s actually helped us survive the ‘80s. Sellers had some equity that they were willing to finance for buyers at a rate less than the banks had available. For example, Baseline subdivision houses in Boulder were priced around $30,000 in 1979. Back then, we thought those were outrageous prices. If the seller had no loan or a large amount of equity, carrying the financing came with an attractive rate of return. At the time, they could carry a note and it might be earning 11%. The bottom line: owner financing on flexible terms helped us sell homes.

As mortgage rates rise, it isn’t quite as easy to come up with alternative financing ideas today as it was in “the olden days”. However, there are a couple of alternatives that are still out there. The first one is FHA and VA qualifying assumptions. Based on those, the buyer still needs to be qualified, but the interest rate will remain the same on assumption. If a seller has a 4% FHA loan, a buyer could qualify for the assumption and take over a 4% loan. The challenge today is that values have gone up so much that the difference between the price and the loan amount can be very large. In this case, the buyer could seek out an institutional second mortgage, or potentially ask the seller to finance the second mortgage.  In the city of Boulder market, FHA and VA loan limits haven’t been high enough to make those loans commonplace, but in lower-priced areas of the county, an FHA or VA assumption could be a realistic possibility.

Values have risen dramatically from 2012 in Boulder County. Many sellers now have strong equity positions compared to the “underwater” days of the recession. Interest rates on savings accounts and very safe investments currently have a low rate of return. This leads to the possibility of a seller thinking that carrying financing can be an attractive alternative for investing their equity. It isn’t as easy today to create an owner financing arrangement as it was in the ‘80s. Nevertheless, added legal structure has been established to make owner financing a practical and realistic opportunity.

Owner financing has evolved over the years. Back in the “olden days” all you needed was a piece of paper and a typewriter to type out a note. Eventually, the Colorado Real Estate Commission came up with an approved note and deed of trust forms that real estate licensees were allowed to fill out. Now those forms are gone, and all owner-financed transactions need to be handled by an attorney or a Colorado-licensed mortgage loan originator. Although owner financing rules have become more complex, enlisting the appropriate professionals can help you assess if it is right for you as a seller.

As a seller, you can meet with an attorney and/or a licensed mortgage loan officer to determine which terms you would like to offer to potential buyers. Once you set those terms, you can meet with your Realtor® to decide how best to market the financing.

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