Help a Reader: Buying a House on Contract

Here's an email I recently received from a reader:

I have been presented with an opportunity to buy a house from my fiance's grandmother.  Her income is tight and we have been offered to purchase the home at a value well below the market price.  I am a self-employed small business owner and my fiance is in her 2nd year teaching.  We both have student loan debt and personal debt.  Bank financing would be difficult for us.

Here are some details:

• Our personal debt includes 950/month student loans, 650/month consolidated loans (credit cards, medical expenses), 550/month car payments, 300/month rent on current house, 400/month food/misc expenses, 150/month utilities.  3500/month income.  We have about $500/month of wiggle room for savings and/or emergencies.  We do not have 20% to put down for a down payment.  No assets.  We are expecting 10k from inheritance in 4-6 months.

• House value is $120k appraised.  We have been offered it for 75k.  Her grandma pays about 325/month on current mortgage plus utilities.  We would like to buy the house on contract by paying her an agreed upon amount per month that she can pay her current mortgage with or save for health expenses that may occur in the upcoming years.  By showing the bank we are paying on a house with contract in hand, we can go to a bank in 2-3 years to borrow the remaining amount and pay grandma a lump sum.

Pros/Cons?  Best ways to go about buying a house on contract?

What advice do you have for him?

Comments

[Hamaca]

I would suggest getting an appraisal that supports the purchase price otherwise the purchase could be viewed as a disguised gift and possibly cause gift tax problems.

[Ben E.]

I think an appraisal of the FMV would be beneficial. How recent was the last one? How much is the left on the mortgage? And if the house with worth that much, I don't think that contracting to purchase it would be a bad idea. However, I might consult a lawyer about how the agreement would be structured.

There are a number ways this could be done - she could deed you the house and you could take it "subject to" the mortgage (or assume the mortgage) (The difference here is whether the bank could hold you liable for the debt in the event a default - 'subject to' a bank could not hold you liable). (You could negotiate directly with the bank and see if they will let you assume the mortgage - they might if you have good credit, etc).

Alternatively, you could enter into an installment land contract whereby your grandma keeps the deed to her house and you pay her fixed amounts for so many years after which she would convey the house to you.

I'm not sure how much longer your grandma will live, but it could be helpful to have your name on the deed too in joint tenancy. That way, the house would not go through probate (if you opted to do an informal written contract...).

I'm not a lawyer, nor do I have expertise in this field, but there are options available to make this work. The best idea would have a lawyer draft an agreement so that you're both protected in case there is a breach by either side (no, you never expect something like that, but still). I think a consulting a property lawyer would be your best bet.

[Mr. ToughMoneyLove]

More money insanity.

"Self employed small business owner" = I don't know if I now have or will have a positive cash flow.

First, you have a large negative net worth. Second, you cannot afford more debt, as you are already on the edge. Third, if you buy or rent the house for substantially below market value from a family member, you are facing potential gift tax and/or imputed income issues.

Get your own financial house in order before taking on more risk and compounding the debt mistakes you have already made.

[M]

It sounds like buying this home subject to the existing note could be a good move. Search real estate investment sites for buying 'subject to;' while you're buying this house as your primary residence, the mechanics of the sale are the same as it would be for an investment transaction.

I'd recommend that you hire a real estate attorney to draw up a mortgage between you and your fiance's grandmother.

You can also contact any real estate investment clubs in your area; they should be able to help you find resources to complete this transaction legally and ethically.

[Wise Money Matters]

Absolutely not.

Issue #1: You want to go into debt even if a bank will not loan you the money. That's just a disaster waiting to happen. There is a reason the bank won't loan you the money. You can't pay it back.

Issue #2: Never do business with family. When some random thing comes up and you can't pay the "mortgage" then you are going to cause a big family fight. It's not worth it.

If you really want to do this, I would offer to help grandma pay the mortgage payment, let her live in it and purchase it from her when you can afford it. You said you expect an inheritance in 4-6 months. Buy it then. Until then just be nice and help grandma with her bills.

[kitty]

"Third, if you buy or rent the house for substantially below market value from a family member, you are facing potential gift tax and/or imputed income issues."

Even if it were a gift - they should ask a lawyer about it - and the grandma has to fill out a form, it's still a non-issue unless the grandma gave a million dollar worth of taxable gifts in her lifetime. From TurboTax instructions: "In 2008 and 2009, you can give a lifetime total of $1 million in taxable gifts (that exceed the annual tax-free limit) without triggering the gift tax. ..."

While going into debt is bad especially in this situation, one special case is when buying will result in smaller payments than rent. This may well be the case in this situation. In this case buying this house will result in smaller monthly payments and will enable them to pay off other debts sooner. They could probably set it up as an owner-financed mortgage - it would be better to hire a lawyer to do it - with grandma holding the lien against the house. Any real estate lawyer can set it up, they shouldn't do it by themselves. Then they can deduct interest, but grandma will have to show it as income.

[Jim]

They have $2,150 in debt payments and $3,500 income. 61% of your income is already going to debt payment.

I don't think taking on more debt is a very good idea right now.

Even if they work a deal legally/ethically to buy this house for the reduced $75k with 5% interest then thats still about $400 a month over 30 years. Plus you'll have property tax, insurance, maintenance, increased utilities, etc. Buying a house could easily increase their housing costs $300 over the $300 they're paying to rent right now.

I'd instead focus on paying down debts then buy a house when they can really afford one.

[cb]

Yeah, with only $500 of wiggle room, you need to save up some $$ before getting into this situation.

Also, if the grandmother's income is tight, shouldn't she be selling the place for the full $120k while you work on your finances. Where is she going to live after the purchase?

Finally, can the deal wait until you get the inheritance? (I hope that isn't the time someone has left in this world!)

[Bill]

Buying a $125k house for $75k is a risk from other "interested parties" when grandma passes away. Aside from gift concerns, you are setting yourself up to piss off other heirs.

The contract idea might work if you did not have such debt (e.g. you have $550/month in cars and only $300 rent???). You have a spending problem, and the added inheritance, gift and debt risk are exactly the types of risk you ignored when you bought your cars, cranked up your credit cards and borrowed for school that only pays 2 people $3500/month. Don't repeat your mistakes. If your incomes have the potential to grow substantially, do it when you save the money. BTW the $10k inheritance should be used to pay off other debt, not buy the house.

[MH]

There is about 25k left on the mortgage. I currently rent a small house from my parents which we have intentions of living in until the grandmother chooses to move out in an assisted living facility or the Good Lord calls her. My career is such that my income will increase. The inheritance money is being gifted to us by my side of the family and not hers, so it has nothing to due with her grandmothers health or lack there of. We have approached a bank and are able to get financing for the offered amount. Thank you for your insight. We can appreciate the numerous factors that play a role in this decision..financially and socially.

[Christine]

If the grandmother has a couple of spare bedrooms, maybe you can become roommates to help her out with personal care, cooking, house and yard work and pay some of the mortgage payment. When she goes into care or passes on, you can refinance the remaining mortgage into your own names. Maybe the house could be considered an inheritance. This works great unless she is going to get medicaid. They actually put a lien on her property for the amount the govt spent on her care. This is usually settled up by selling the property and giving the govt it's share and you walk away with the rest. Talking to an estate atty might be beneficial here.

[JimL]

As others have said, you do not need more debt at this time. Instead, you should be picking up a part-time job to eliminate the debt you currently have. You car payment is also horrible. You need to get rid of the expensive car and drive a beater.

Prior to buying a house, you need to be out of debt, 20% set aside for a downpayment and at least 6 months expenses in an emergency account. Homes need repairs and a bad roof or furnace can create a big unexpected hit.

[Debbie]

I don't see how you would be assuming more debt. It stands to reason that your payments will be lower than what you are paying now. My only advice would be to consult a lawyer because this is a huge decision. I would not pay much attention to all of the naysayers with the negative comments. You and your significant other sit down with you lawyer and the three of you decide what will be best in the contract purchase of this house.