Creative Finance by Robert G Allen

[Brian Gibbons]

CREATIVE FINANCE - by Robert G Allen
Co-Author of "The One Minute Millionaire

5.1 GENERAL CONSIDERATIONS
What really separates the sheep from the goats in real estate investing is the skill of putting financial deals together in creative ways. The nickname for this skill is
"creative finance."

The term "creative finance" has been used so often in so many different contexts that it has taken on the aura of a cliché. Our purpose here is to attempt to define the term in practical, down-to-earth ways that will demystify what is, after all, a very learnable skill, i.e., putting profitable deals together so that everyone wins.

Ask the man on the street what "creative finance" means and you will get a variety of answers:

* clever ways of coming up with cash
* innovative solutions for bridging the gap in making deals
* "cookie cutter" formulas that can be repeated over and over again in order to buy and sell assets successfully
* sneaky deals à la Donald Trump, etc.

Let us take a very different approach to defining "creative finance," i.e., not as a fixed action or thing, but rather in terms of ranges, or rather a series
of points moving along a range of options that relate to certain financing issues.

AN ILLUSTRATION
Let us take one of those issues in order to illustrate what we mean.

If we want to purchase an asset or a property using the time-honored approach of
"cash on the barrel," then we settle on a price with the seller and reach into our pocket
and give him/her the agreed-upon value in the form of currency. That enables us to walk away
with the property or asset and call it our own. We are happy, assuming the thing we have
purchased is what the owner has represented it to be; and the owner is happy because
he has his money.

Creative finance? Not in the least. This is the most ordinary, mainstream, garden-variety
financing in the world. However, what happens if we don't have the money it will take to
buy the property or asset, but still really want it? Then we must turn to our creativity
in order to consummate the deal. Where will we get the money from? Suppose we have a friend
with plenty of money and a willingness to share with us the thing we want to buy.
If we now bring our friend to the negotiations and say to the seller:

"Mr. Seller, I want to purchase your property for the price we have agreed upon,
and I have a friend here who will put up the money."
Will the seller object to that? Not if the money is bona fide currency.
Thus you and your friend can walk off with the property or asset, share it according to
your arrangement, and everyone is happy.

Especially you, because you didn't put up a dime--and still get to use the property.
You have just used creative finance to close a deal.

The issue here is one of several that go to define "creative finance."
In this case we are asking, "Who will put up the finances?"
In our example, your partner put up all the
financial resources. But it is possible that you could have put up
some and he/she could have put up some--a combination of
shared investment.
Maybe you put up half and your partner puts up half.
Or maybe you put up a fourth and your partner puts up threefourths.
Or maybe you put up 37.681 per cent and your
partner puts up 62.319 per cent. Whatever! It's a matter of
mutual agreement. That kind of arrangement makes it clear that
we are talking about a range of options all relating the issue of
who puts up the finances to close the deal.
From your perspective, the range covers all the
possibilities from your putting up all the consideration (hardly
creative) to your putting up none of the consideration (highly
creative)--plus every possible combination in between.

Issue: "Who puts up the finances?"
YOU or SOMEONE ELSE?

We can define "creative finance" as a financing arrangement in which the
maximum share of the invested finances comes from other people rather than
from yourself. The more you can induce others to pay, the more creative
the deal. The better you are at structuring financial arrangements
in which your input is minimized and the use of other people's money
is maximized, in the context of everyone winning, the more "creative"
you are at financing.

continued....

[Brian Gibbons]

5.2 THE MAJOR FACTORS OF CREATIVE FINANCE
There are at least seven other major factors that figure
into the process of creative financing. Here is a listing of these
issues, including the issue of OPM (Other People's Money) that
we have just discussed. Each of these issues generates a range
of options that can serve to define more fully the nature of
creative finance from the standpoint of the results it brings:

1. AT WHAT PRICE?
Range: from high above the market to high below the market
Commentary: all other things being equal, you are going to be looking for a price as far below the market as possible. It doesn't take a lot of additional creativity in a deal if you can get it at 30% or 40% below the market. That may well be "creative" enough, because you pick
up a big chunk of equity as the outset, before anything else happens.

2. USING WHOSE FINANCIAL RESOURCES TO BUY?
Range: from our own resources to other people's resources Commentary: as we have already explained, if there must be money put into a deal, then let it be someone else's money. This is especially true if you don't have any money! Sometimes circumstances constrain you to
be creative in this sense. A lot of deals are creative because they have to be!

3. HOW SOFT OR HARD ARE THE "OTHER PEOPLE" INVOLVED?
Range: from bankers to partners to sellers, i.e., from hard to soft
Commentary: it's one thing to depend on other people's money; it's another to make sure you are dealing with the right kind of "other people." The terms "hard" and "soft" are ways to characterize "other people" by how tough they are with the terms of the deal. Typically
bankers and institutional lenders are more conservative and demanding when it comes to the terms of their involvement. They want to check you out and force you to pass through their fine qualifications filter before they will let you have their money. They want to charge you as high an interest rate as possible (especially the "finance institutions" of the type that specialize in second-mortgages), and they watch you like a hawk to
make sure that you pay every penny back on time.

That's why they are characterized as "hard money" lenders. Alternately, sellers can be "soft," i.e., they might be willing to play banker for you without any scrutiny, credit checks, or behind-the-scenes detective work.

The more anxious the seller is to sell, the more willing he/she might be to carry back a portion of the equity in the form of a note. That's why sellers are at the high end of the creativity scale. Generally the more creative the investor, the more he/she will push for seller involvement with the financing.

Partners occupy a somewhat intermediate position on this scale. They have to be courted, like the hardmoney people, but they may be more flexible and willing to deal by qualifying the deal more than the
person. Still, they are not as soft as the seller, because they are going to want their pound of flesh in a timely manner. They are going to watch the pot boil to make sure they get their just dues.

continued..

[Brian Gibbons]

4. WITH WHAT SIZE OF DOWN PAYMENT?
Range: from 100% of the value up to 0% of the value
Commentary: with creative finance you throw out the traditional down-payment rules and negotiate what will get the deal done in a win-win fashion. Naturally, you have to do this in the context of the numbers, since "nothing down" deals are a dime a dozen if you are
willing to buy into "alligators" with high negative cash flows. The trick is to get away with the minimum input of capital and still have positive cash flow.

Some people with unlimited resources or well-heeled partners will argue that the best way is to pay all cash and force high front-end discounts. They give up downpayment creativity in favor of discount creativity. You can't argue with them--unless you are broke and have
to fall back on low-down deals in order to survive.

We'll have more to say about this below.

5. WHEN IS THE DOWN PAYMENT DUE?
Range: from way before the deal is closed to way after the deal is closed
Commentary: all other things being equal, you may want to put off the inevitable as long as possible. You may even want to take the down payment and spread it out over the initial period after the deal is closed so that it never bites you too hard--assuming the seller will let you get away with it. Creative deals sometimes have to be structured around down-payment flexibility. The trick is to realize that there can be flexibility in such cases. Sometimes all you need to do is ask. In the
"asking" is the creative energy!

6. IN WHAT FORM OF CONSIDERATION?
Range: from cash to property to secured paper to unsecured paper
Commentary: the further away from cash, the more creative. What if your seller is willing to take some personal property in lieu of cash? What if he/she won't take property but will take a note secured by property (such as real estate)? What if the seller doesn't insist on
the note being secured, and just takes a piece of paper with your promise on it (i.e., an unsecured note)? All of these possibilities form a sequence from less creative to more creative. If you don't ask, the assumption is "Give me cash." But if you ask creatively, you can sometimes get away with "murder" and still have a win-win deal.

7. AT WHAT RATE OF INTEREST ON THE UNPAID BALANCE?
Range: from way above the market to way below the market
Commentary: often this factor is tied in with other creativity factors in the deal. If you don't get your way with one of the other factors, you might insist on forcing the interest rate down (and hence the "creativity" up).

Alternately, if you want to force your hand with one of the other factors, you might choose to yield on the interest-rate factor. This may make you seen to be less creative with respect to it, but you will get even on one
or more of the others! More of this later.

8. FOR WHAT REPAYMENT TERM?
Range: from long-term to short-term
Commentary: all other things being equal, the longer you can postpone the repayment, the better. The reason for this has to do with the time value of money.

The longer you have your money in your own clutches, the more you can put it to work for you. The moment you pass it on to the seller, you lose the option of putting it to work for you. Naturally, this has to be
counterbalanced against the cost of borrowing it from the seller.

In each of these eight ranges, creative finance can be defined as a point along the line defining the range: the further the point moves along the line, the more "creative" the deal you have put together.

continued..

[Brian Gibbons]

5.3 CREATIVE FINANCE SCORE CARD
Let's put our findings in the form of a chart summarizing the eight scales we have used. Let us give our ranges a span of five points for the sake of relative comparison. What we are doing is separating "creative finance" into its constituent parts in order to gain a better understanding in how deals are put together. This is called the analytical approach. Later on we will talk about creative finance in terms of a synthetic approach where we see how combinations of factors add up to optimum results.

Each deal is a little different, with different sets of demands and needs. We are attempting to set up a way to "keep score" in the game of creative finance, to measure the degree of creativity needed in order to put deals together.

A HYPOTHETICAL CASE STUDY
Let us suppose, for example, that you want to purchase a valuable painting and are able to structure an arrangement according to the criteria listed above, with the following details.

How creative is your deal?

1. AT WHAT PRICE?
You are able to negotiate a price that is 50% below the market for the painting in question. Thus, whatever financing source you come up with, you are already 50% ahead of the game. Since 50% below the market
can be considered a very unusual opportunity, your creativity shoots to the top of the range in this case.

2. USING WHOSE FINANCIAL RESOURCES TO BUY?
You are able to set up an arrangement where little or none of your own resources are to be put into the deal, hence your creativity along this scale also rises to a point close to the top.

3. HOW HARD OR SOFT ARE THE "OTHER PEOPLE" INVOLVED?
Now, who your participating partner is in the deal is very important from the standpoint of creativity. Let us take the position that the most desirable partner is the seller himself; the next most desirable partner would be one or more non-institutional investors or participants
within your circle of acquaintance; and the least desirable source would consist of the hard-money lenders.

The reasons for this judgment are fairly obvious: sellers who serve as bankers usually don't require involved credit checks or approvals by august high-level committees; non-institutional partners, while usually requiring a good piece of the action are still easier to work with than the hard-money lenders.

Let us suppose in our illustration that you are able to induce the seller himself to finance the purchase of the painting. Thus your "creativity" stock rises upward along the vertical line toward the top, since this kind of financial arrangement is perhaps the least "mainstream" option you have.

4. WITH WHAT SIZE OF DOWN PAYMENT?
Let us suppose your seller insists on at least 5% down, despite all of your creative badgering. Your creativity in this regard does not go completely to the top, but at least it approaches maximum.

5. WHEN IS THE DOWN PAYMENT DUE?
The good news is that you ask your seller to allow you to delay payment of your 5% down payment for six months--and much to your surprise he agrees! This is not "much later," as indicated on the payment-due scale, but at least it carries you upward toward the top.

6. IN WHAT FORM OF CONSIDERATION?
You talk your seller into letting you take care of your payment obligation in the form of an unsecured note that provides for monthly payments. Thus your "creativity" in this regard is high.

7. AT WHAT RATE OF INTEREST ON THE UNPAID BALANCE?
You work hard to come to terms on this issue, but find that your seller simply won't go lower than market rate. Your creativity in this regard is only moderate, but at least you got him to come off his initial insistence that you pay him several points above the market due to the fact that you were giving him an unsecured note.

8. FOR WHAT REPAYMENT TERM?
When it came to this issue, you were somewhat embarrassed to ask your seller for ten years to service the note. Much to your amazement, he accepted. Thus your creativity on this scale rises to the top.

Now, if we take our hypothetical example and assign a score for each of these eight ranges of creativity, you can come up with a chart
From your chart it is apparent that your deal was, on the whole, very creative indeed. You bought a valuable asset at 50% below the market (1) without a dime of your own money

(2). In fact your "banker" was the seller himself (3), who was satisfied with only a modest down payment (4) delayed for a full six months (5). Your payment was to be in the form of an unsecured note (6) no higher than market rates (7), with a long term for fulfillment (8).

continued....

[Brian Gibbons]

Not bad! If we assigned an actual comparative score to this transaction, then you would have scored 5, 5, 5, 4.5, 4, 5, 3, 5 for a total of 36.5 out of a possible 40 points. This works out to 91.3%--which would give you an "A" in a creative financing course at college.

Compare this with the fellow who might have walked in with a pocket full of money and simply plunked down the equivalent of the full market price for the painting. He would flunk our course outright!

5.4 TRICKS OF THE TRADE
"But," you say, "is there not something missing? Where are the neat little tricks and innovative twists that I often associate with so-called 'creative financing'? Where are the brilliant flashes of intuition that get over the hurdles and around the obstacles?"

Good point. Our little illustration gives only the highlights and doesn't let us in on any of the behind-the-scenes intrigue that we like to imagine as the fabric of creative finance. Okay, have it your way. Let us fantasize a little and hypothesize what might have contributed to the creative facilitation of this deal.

What will surprise you is that you really only need one major "trick" to make creative finance work in your favor, the trick of tradeoff. In other words, most of your bargaining power comes from within our range in the form of yielding on some issues in order to gain on others that may be more important to you. Your seller is really not fully aware of your
tolerance levels with respect to the eight issues included in our
lineup. He/she does not know which of the issues is critically
important to you on the basis of your circumstances.

For example, what if you are flat broke and therefore you must have your way with respect to the second issue (OPM). You simply have no choice but to look to the resources of others to swing the deal. Furthermore, what if you have poor credit and no partners to step in from behind the scenes, and thus the OPM you must turn to is the seller himself.

How can you assure yourself that the seller will finance the deal? Easy. You give up something in one of the other categories of less importance to you than that. For example, you might yield on price, even giving the seller above-market consideration for the asset you are purchasing. Or you might give the seller a higher interest rate that you would normally
tolerate.

Alternately, you might yield on the form of payment. For example, if the seller demands some form of down payment so that your neck is on the line, but you don't have cash to give him/her, then you might consider property, i.e., personal property instead. You could give up a car, boat,
horse, or whatever else you might have that would satisfy the need. Moreover, if you are offering a secured note as the instrument of payment for the obligation, you could increase the security on the note in exchange for the OPM/Seller Finance issue.

For example, if it is real estate you are purchasing, you could secure the note not only with the subject property as collateral, but with other properties you might already own. The technical term for this creative technique is "the blanket mortgage," because it covers two or more properties at once and thus increased the collateral of the seller and therefore the trust and tolerance factor.

To use a further example, suppose you have plenty of your own money to use in a deal, or at least access to plenty of money through partners, but you are very keen on price. In that case, you might yield on the second and third categories and focus on what is more important to you: price. Your hot button is to acquire the asset at a price that is far below the market so that you will be picking up great amounts of equity right from
the start. Here you can yield on some other issue, such as the form of payment, in order to get what you want.

The name of this game is "cash talks." Rather than exerting your creative muscle to pay in the form of non-cash resources, carry-back notes, etc., you simply reach in your pocket (or your partner's pocket) and pull out cash. But you insist on lowering the price in exchange for giving up that cash in the deal.

5.5 THE BIG SECRET
By now you know the big secret about creative finance: i.e., there is no big secret. It really amounts to mixing and matching your options within the range grid we have outlined. Creative finance means being creative in how you mix these options in keeping with your own circumstances.
Your motto is: "You win some battles and you lose some battles, but you always win the war." In other words, you are purposely uncreative in some categories in order to be creative over all and bring home the bacon.

Does that make sense?

5.6 CREATIVE FOOTNOTES
Now, having covered that point, we hasten to add that the whole world of creative finance is not covered by our simple chart. There is much room for your own creative thoughts and strategies outside this chart. You will learn how to add other categories and tricks that harmonize with your own style and needs.

For example, what if your interest in not to acquire an asset immediately but only to get control of it for a time. Then your creativity will suggest to you getting an "option" on the asset. In real estate or business acquisition, it is possible to tie up an asset with an option that gives you a chance either to find another buyer who will give you consideration for your option, or to find the financing to buy the property outright. In any case, the proper instrument in this case is the option instrument, or the lease-option. You don't purchase for the time being, you just control.

Furthermore, you will become very adept at facilitating creative deals by offering things that are out of the ordinary. If security is a big thing with a given seller whom you are approaching on a seller-carry-back basis, then it might occur to you to take out an insurance policy in the name of the seller in order to add security to the deal. If you are short on cash and personal property to put into a deal, then you might use your
credit to buy something on time that the seller wants as part of the consideration. Or you might take over an obligation of the seller on another of his assets and shift the credit back to the asset you are interested in buying. If you don't want to refinance a target property as part of a purchase, you can use a "wraparound" mortgage or contract instrument to purchase it, etc.

Where do such facilitative ideas come from? Your creative brain--encouraged by the circumstances you find yourself in. Often the choice of trade-off is dictated by your circumstances--thus there is no creativity about such choices.

You take a certain approach because you must take it. The creativity comes in mixing and matching the trade-off parameters. In fact, virtually all of the so-called "cookie cutter" techniques are rooted in our creative finance grid, sweetened by small creative gestures along the way to grease the skids. In our next section, we'll turn to some of those cookie cutter techniques to show you how they can be used.

[Brian Gibbons]

5.7 SIX UNIVERSAL CREATIVE FINANCE COOKIE CUTTERS

Let us discuss six of the "classic" creative finance techniques that everyone needs to have in his/her arsenal of strategies. As we discuss these techniques, we will refer to our creative finance chart to see where a given technique fits in.

5.71 THE ULTIMATE PAPER OUT
Every investor has a secret desire to trot into a deal and trot out with a valuable asset without putting anything down. Naturally, in the case of an income-producing asset, this desire includes no negative cash flow
Are such deals possible? Yes. All the time. Ask any veteran who has used his benefits to purchase a house for nothing down (here the "negative" cash flow is tolerable because it amounts to rent).

Such deals are even possible for the real estate investor--if he/she is willing to look around to find the ultimately flexible seller.

Let's suppose we can find a flexible seller who is willing to carry back paper on a property in order to facilitate the sale. He is not willing to discount the price, so we cannot be creative in that regard. But he is willing to take on the role of banker. Why would a seller be flexible in this regard? Perhaps his property has been on the market for a long time and he is weary of the hassle of trying to get it sold. Perhaps he has a large portfolio and needs to reduce a tax burden. Perhaps he is
just a philanthropic old gentlemen who wants to help us out!

For whatever reason, he is willing to carry back. If the carry-back is for 100% of the seller's equity, then we have a so-called classic "Ultimate Paper Out." Very likely the seller will demand and get his full price. Possibly he will also insist on a fairly high interest rate. And perhaps he will want a balloon payment in the short term (three to five years).
You may even have to "sweeten" the deal by offering a blanket mortgage to increase the security for a time. Perhaps you will have to purchase an insurance policy on your own life, with the seller as beneficiary, in order to get the deal closed. All of these inducements and sweeteners don't really matter to you. You do what it takes to close the deal and take advantage of the one creative factor that really matters to you:
nothing down. Naturally, you will have done your homework by assembling good evidence that the property will likely hold its value or even appreciate in time to come in and solve the balloon problem. Naturally you will have looked into the bottom line to assure yourself that you will have positive cash flow despite the 100% financing on the property.

On your creativity chart for the Ultimate Paper Out, we will note that the price may be at the market level or even somewhat above (score 3 or lower). Who pays will be OPM (other people's money--score 1). Hard or soft will be the seller (score 1). How much down will be zero (score 1). When due will be a moot point in this case (there is no day of reckoning-- score 1)!.

Form of pay will be secured note (score 4). The interest rate will probably be at market levels or somewhat higher (score 3). And the term will likely be intermediate and perhaps somewhat shorter (score 3).

5.72 BLANKET MORTGAGE
In the "Ultimate Paper Out" we mentioned the possibility of cementing the deal with a "Blanket Mortgage." Let's go back and analyze what that means in terms of our creativity grid. The Blanket Mortgage is really an inducement technique that falls under the "Form Of Payment" column in our creativity chart. The logic of it is quite simple, especially in a
nothing down deal. The seller in a 100% carry-back situation will say to himself: "Why should I let this investor take over my property with nothing down?

If his head is not on the block, then he may not follow through. With nothing invested, he has nothing to lose."

There is a compelling logic to this conclusion.
A nothing down investor may really not have much to lose in just walking away from a deal that isn't going his way. Hence security becomes an issue for the seller.

How can you increase the seller's security and still take
advantage of a nothing down deal? The answer has to do with the nature of a secured note. A mortgage is really a combination of two interlocking instruments: a promissory note and a collateral agreement. In essence, the note memorializes your promise to pay a certain sum of money according to agreed-upon terms. The collateral agreement pledges something of value to back up your promise. If you don't perform on the note as promised, then you allow the holder of the note to take over the property (collateral) you have pledged.

In most real estate transactions, the collateral is in fact the subject property itself that is being purchased. If the seller turns over a property to you then you give back a trust deed note (or mortgage note) plus a security agreement pledging the subject property as collateral.

But what if you pledged more than the subject property? What if you secured your note with the subject property plus something else of value, such as another property you own? If you offer more security in this way then you are setting up a "Blanket Mortgage" or "Blanket Trust Deed" situation.

Why would you want to do this? To help the seller overcome his security doubts in a nothing-down situation. The Blanket Mortgage is a financing technique that is analogous to a "security blanket" for the seller. You say to him: "I'll give you a security blanket if you give me a nothing down deal."

Naturally you will want to include in your Blanket Mortgage Agreement a provision to release the second property as collateral in the event you perform on your agreement for a specified period of time. Let's say if you make all of your payments for a year in a timely way and keep the property in good condition then the additional collateral can be released. In a year's time, the value of the subject property may well have increased in value anyway, thus increasing the seller's security.

The "Blanket Mortgage" creativity chart will look just like the chart for the "Ultimate Paper Out." The variation is that you will be using an additional property as collateral for the secured note.

[Brian Gibbons]

5.73 SECOND MORTGAGE CRANK
The term "crank" is an old creative finance term that implies pulling money out of a property at closing, or "cranking" money out of a property in order to close a deal. In order to crank money in this way, there must be considerable equity in a property. In fact, the "Second
Mortgage Crank" can only work well if the financing on a property is 25% or less. Where there is 75% equity in a property, the parties to a transaction can use their creativity to arrange a win-win deal.

How does it work?
What is important to the seller is to get a lot of his equity converted to cash. What is important to the buyer is to get into the deal with little or none of his own money. Thus the buyer will probably have to yield on price and terms in order to get "creative" with the source of the funds to buy the property.

There are two variations:

A. SELLER REFINANCE
In this case, the seller, in order to facilitate the sale, agrees to refinance the property himself with around a 75% - 80% new loan, pay off the existing loan (which should not exceed 25% of the value of the property), and take the balance of the refinance proceeds in the form of cash. The buyer then gives the seller a second trust deed (or second mortgage in
some states) for the remaining portion of the equity. Thus the
buyer gets in for nothing down. Again, there may need to be inducements like a "Blanket Mortgage" for the carry back portion of the deal, or an insurance policy with the seller as beneficiary. Or the price
of the property or the interest rate on the second may need to be generous for the seller.

The key is for the buyer to creative where it counts. Why would a seller go to the trouble to refinance the property himself and "cranking" out his own proceeds? Perhaps he has had difficulty selling the property and needs to do something special to get rid of it. Perhaps he is tempted by a
price that is generous, or perhaps the buyer pays back a bonus when the second is paid off. With some clever negotiating, such deals can be put together.

B. THE "CLASSIC" SECOND MORTGAGE CRANK
With this variation, the buyer takes out a new loan on the property, pays off the existing loan, and gives the proceeds to the seller. The down payment (which is always essential in a new hard-money loan that is part of a purchase) comes in the form of a note that the buyer executes in favor of the seller, using another property as collateral. In other words, there is no second trust deed (or second mortgage) on the subject
property; rather, the buyer has paid for the remaining equity in the form of a note--which does indeed have value. The seller does indeed receive consideration for his remaining equity, but it is not in the form of cash. It is in the form of a note secured by another property. Thus there is no secondary financing on the subject property--just the new first trust deed (or mortgage).

What is the catch? No catch. Just the need to find a lender that will be willing to arrange for such a transaction.

What if the lender wants proof that the down payment part of the transaction has really come out of the buyer's pocket. In that case, the lender may require the seller to sign a "verification of deposit" stating that the seller has received consideration for his equity in the form of an exchange. If the lender is aware of the kind of consideration involved, perhaps he will require that the note by appraised in order to demonstrate that the requisite value in there. It stands to reason that lenders will be more amenable to this kind of creative financing in times when capital is plentiful.

In any case, the money needed to complete the deal has been "cranked" out of the property (in the form of the proceeds of the new loan less the payoff for the old loan). Actually, the remaining proceeds to complete the deal have also been "cranked" out of the secondary property in the form of the exchange. It's like a double crank.

This is the classic form of the Second Mortgage Crank because the seller does not need to do anything except agree to a highly creative deal.
Once more, the buyer is likely to yield on the factors of price, interest rates, terms, etc., in order to get the advantage concerning the source of the capital. Thus the creativity is selective.

If you do a chart on, the "Second Mortgage Crank" you will note that the price will probably be at market level or higher (score 3). Who pays will be OPM (score 5). Hard or soft is a mixed bag: hard for the bank (score 1) and soft for the seller (score 5). The average will fall in the middle, so score 3 for this factor. How much down will hopefully be zero (score
1). When due--score 1 again because without any down payment, this point is moot. Form of pay is a secured note (mortgage or trust deed--score 4). Interest rate will probably be at market level or higher (score 3). The term will probably be intermediate or longer (score 3).

5.74 WRAP-AROUND MORTGAGE
What happens during tight-money times when the poor old buyer cannot qualify for a loan in order to buy a property? There is a powerful variation on the seller-carry back that works well when the underlying loan has a relatively low interest rate and when that loan is assumable.
Let's say the seller has a $100,000 property with a $60,000 mortgage at 8%. The seller's equity is therefore $40,000. You want to buy this property but cannot qualify for a new loan to buy the seller out. What can you do?

continued...

[Brian Gibbons]

You can give the seller a new mortgage that incorporates the old and a large part of the seller's equity. Let's say you can come up with $10,000 down in cash and give the seller a new mortgage for $90,000 at 10% interest. This new mortgage "wraps" around the old underlying mortgage of $50,000. There is a $40,000 portion of the new mortgage that
covers the rest of the seller's equity. We refer to this financing instrument as a "Wrap-Around Mortgage" or "All-Inclusive Trust Deed (AITD)."

Why would a seller carry back such a mortgage? One reason is that he is getting 10% interest not only on the $40,000 portion, but also on the underlying $50,000 portion as well. Thus he gets a 2% "spread" on the underlying portion--which he can put into his pocket until that underlying mortgage has been paid off. Alternately, you may perhaps agree to terms that will require you to pay off the new mortgage before the underlying mortgage comes due. In that case, the proceeds you
deliver will pay off the new mortgage and old mortgage at the same time.
Thus you have yielded concerning the interest rate, and possibly the time span, but have gained in the area that is important to you: who comes up with the money. True, you probably have to come up with a down payment, but the rest of the equity is financed by the seller himself. And perhaps you can negotiate a price that is below the market. These factors make this deal creative.

How do we score this technique on your creativity chart? Hopefully the price can be somewhat below the market (score 4). Who Pays? Essentially the seller carries back for much of the equity, so score 4 for this part. However, you may have to put something down (score 1). The average will be around 2.5 on the chart for his factor. Hard or soft (score 5). How much down (score perhaps 4 since you may have to put some money down on the deal). When due? Probably at close (score 3). Form of pay? This is a blend of cash for the down payment (score 1) and secured carry back (score 4). The average will be around 2.5 for this factor. The interest rate will likely be at the market level (maybe somewhat higher to induce the sale--score at least 3). The term will likely be intermediate (score 3).

5.75 CREATING PAPER
Few people realize that things can be bought with "paper," but it is true. If you start to build up a portfolio of real estate properties with growing equities, you can begin to take advantage of these assets by using them in cash-less deals.

It works like this: if you find a property that you would like to acquire, you can offer the seller a note as down payment, in lieu of cash. The note can be secured by the equity in one of your other properties.
How do you create paper? You sit down at a typewriter and write out a promissory note. Then you back it up with a security agreement that pledges your real estate as collateral.

If you prefer, a title company or attorney can whip this kind of instrument up in no time.

Then you take your note over to the seller and say: "I want your property, and here is a note as down payment."

Naturally, the terms of the payments on the note will have to be worked out, just as with any note. And you will have to perform on the note, or else the seller is entitled to take over the collateral for the note.

But the beauty of creating and using paper in this way is that it permits you to buy property without cash (or with less cash). And you can put your portfolio to work while your equities are growing. Furthermore, the subject property is not encumbered with any carry-back financing, thus leaving you free, if you choose, to refinance it, and pull out money for other purposes.

Why would a seller accept a note in lieu of cash? Not all sellers will do this. But an anxious seller, or one who is used to creative financing techniques, might be most willing to engage in this kind of deal-making. It is better to pick up a performing note than not to sell the property at all.

Now you may have to be generous with the price and terms in a paper deal. But you will have your way concerning the form of payment. Thus your creativity is selective where it counts. How will you score this technique? Your price will likely be around the market level (score 3). Who pays? In this case you do (score 1); however, you are the softest form of revenue (hence score 5 for hard or soft). Score 4 for down
payment. When due? At closing, hence score 3. The form of payment is a secured note (score 4). The interest rate will likely be around the market rate or higher (score at best 3). The term will likely be intermediate (score 3).

5.76 LEASE OPTION
A powerful way to have your cake and eat it, too, is to get control of a property through a Lease With An Option To Purchase.

This is using your "creativity" without even purchasing anything except the right to purchase. With the Lease Option you can make use of the subject property under the terms specified in the agreement, plus you have the right to buy the property at a certain price within a certain time frame. Typically you must pay something for the option (anywhere from a few hundred to a few thousand dollars); however, a portion of the monthly rental fee can be applied to the eventual down payment or purchase price. Thus a lease option is almost like a purchase where the down payment is paid over time. Moreover, the prospective buyer will want to lock in a price that will be advantageous at the time the option
is due. It is a gamble, of course, but by locking in the price for one, two, or three years (whatever the term of the option is), he might just be able to get the property at a good discount when the time comes. This would be analogous to a "below market" deal when the purchase goes through.
Why would an owner agree to a Lease Option? It could be that he has had trouble selling it and thus wants to attract a larger prospective audience. Certainly a lease option will make his management burden lighter since the tenant will want to treat the property with the respect due to a future acquisition. The seller also retains the tax advantages of
ownership until the option is exercised and the title passes to the new owner. Plus the option money is not taxable until the option is exercised. All in all, the Lease Option can be good for both parties involved.

Naturally the greatest advantage for the prospective buyer is that he can control the property without having to come up with much cash.

5.8 ASSIGNMENTS
1. Define "Creative Finance."

2. What is the "secret" to Creative Finance?

3. Using your own Creative Finance Score Card, chart out the following techniques:
Ultimate Paper Out
Second Mortgage Crank
Wrap Around Mortgage
Creating Paper

3. What is a "Blanket Mortgage" and when is it useful to include
in a deal?

4. In which kinds of situations is the "Second Mortgage Crank"
most viable?

5. What are the benefits to the "Lease Option" technique for
both buyer and seller?

6. What is the greatest liability with a pure "nothing down"
technique?

PRACTICUM
Contact at least ten sellers and negotiate a financing solution for each property being offered. Use the mix and match approach to arrive at a viable solution.

The "Situation Analysis Matrix" Chart included on the next page may assist you to identify the creative finance techniques that relate most to the circumstances at hand.

SITUATION ANALYSIS MATRIX
SIX UNIVERSAL CREATIVE FINANCE COOKIE CUTTERS
AND WHEN TO USE THEM
1. The Ultimate Paper Out
2. Blanket Mortgage
3. The Second Mortgage Crank
4. Wrap-Around Mortgage
5. Creating Paper
6. Lease Option