We're watching a train wreck in slow motion. An agent we know, let's call him Ralph, has a new buyer couple under contract for an entry level home. They are inexperienced, but eager to get into their first house, and not terribly receptive to Ralph's advice.
In meeting with their lender on their FHA loan, the buyers mentioned that they were hoping to redo the kitchen after closing. "Oh, I can help you with that", said the lender. The FHA application went into the trash, and the buyers were led off into the realm of private lending, where it appears that they will make a tasty feast for the foul creatures that live there.
Ralph was first made aware of the switch when the buyers informed him that an appraisal wouldn't be required since they were going to do a "construction loan". Huh? Ralph initially thought they were talking about an FHA 203 loan, and was pretty sure an appraisal was necessary for that. But he eventually heard the phrase "private lender" and started to get really concerned. And it got a lot worse when he got a look at the loan estimate and promissory note.
Here's the details:
- The purchase price of the home is $270K.
- The lender is providing another $20K for renovation costs.
- The loan is classified as a conventional loan, with a term of 6 months. There is no provision for an extension. At the end of 6 months, the buyers will have a balloon payment of $292K.
- The interest rate for the loan is 7%.
- The closing costs for the loan are $17K, including an $11K loan origination fee, making the effective APR 16.011%.
Assuming the buyers can refinance into something a bit more long-term after 6 months with a completed $20K kitchen renovation - keeping in mind that there has been no current appraisal on the property, and the buyers' credit is merely okay - they will have already spent $314K on the purchase and loan acquisition costs.
And if they can't refinance, the private lender can foreclose. When the buyers, at Ralph's insistence, asked about this exposure, the lender said not to worry, he'll get them into another loan at that time. And I'm sure the terms and conditions on that loan will be really special as well.
I'd guess all of this is legal, and that the proper disclosures have been provided and procedures have been followed. And I'm sure loans like this have a place with savvy investors who have their act together and can handle the risk. But that's not these buyers. And Ralph has done everything he can to make them aware of the risk they're taking on, but they aren't really listening.
The buyers still have a few days to get the message and cancel the contract. Keep your fingers crossed that they make the right decision.
Comments(31)