What to do when the market value of the home does not cover the cost of the loans.

What happens when the price drops so low that you cannot pay back the loans?

When you have hit this point it is time to consider alternative payment options. Creative financing can help pair a buyer who is willing to pay higher prices with a home that is worth less than the loan amounts.

Option 1: Rent the home.

First, you must ask yourself if you would be willing to maintain the home as a rental. By renting the home, you take in monthly income that helps pay down the debt. As long as your loan is not “interest only”, this technique will lower the debt over time until the debt is below the market price. And, as the value of the home climbs with the local market, you may actually find that this is a great way to build retirement income.

Option 2: Rent-to-Own

Second, if you don’t want to be a landlord, you can often find a buyer who does not qualify for financing and enter a rent-to-own contract. You retain ownership of the home until the tenant either qualifies for a loan and buys you out or until the final payment is made.

I usually recommend pricing the rental agreement over 15 or 30 years at an interest rate that is 1 or 2 percent over current mortgage rates. The 30-year option usually provides the most success for me by making the home affordable. You then explain to the occupant that they are paying higher-than-normal interest rates, and the purpose of this is to encourage them to save money by qualifying for a loan as quickly as possible to buy the home officially.

As a condition of the contract, make the tenant responsible for all expenses that you would normally be responsible for. Remind them that they are treating the home “as if” they were the owners, so they are responsible for hiring their own contractors to perform all work.

Protect your interest in the property by adding the following terms to the agreement. First, you want regular inspections of the home so that you can see that they are maintaining the property well. Second, all work done to the property must be done by licensed contractors. Third, if they fail to maintain the property to the standard you have set in the contract the contract can be terminated at your option and they will loose any rents paid. (Make sure you have a lawyer draw up the agreement so that you word these terms in ways that are most easily enforced given local laws.)

Unlike the rental option, this option allows you to transfer maintenance headaches to the tenants. Tenants who will someday own the property are often willing to pay just a little more for monthly expenses which will help you pay down your debts. Additionally, the price structure and repeated reminders that they would save money by purchasing the home from you will encourage them to make the home purchase.

In this option, you expose yourself to the risk that the tenants will not maintain the property well, because they think that they are the owners and as the owners they are willing to let certain things slide. Schedule and keep the regular inspections to minimize this risk.

Option 3: Offer a Seller Holdback

This last option actually transfers title to the new owner and makes you the bank. With a seller holdback, you sell the home to the occupants and the escrow company drafts a loan agreement between you and the buyer. The downside to this agreement is that it often requires that you pay off the previous mortgages, which we have already established is not possible in your current situation.

One way to avoid this is by specifying that as part of the contract terms that the existing debts will remain open until your loan is paid in full. This gives the buyer the option to refinance at any point in the future to pay you off (and the associated debts).

The risk with this option is the “Due on Sale” clause of most mortgages. Most mortgages include a “due on sale” clause that makes the balance of the entire loan due at the time title transfers. Banks often do not exercise this option, but it is their right to exercise whenever they want after transfer. Your risk is that the bank will foreclose when you cannot pay off the note.

Minimize this risk by making regular payments. Never pay late. The foreclosure process costs money that banks do not want to spend. As long as they are receiving reliable and regular payments, you minimize the risk that the bank will foreclose on your note.

This option is the most risky because of that “due on sale” clause, and it will make everyone in the transaction nervous. Expect some resistance from your escrow officers and agents when you propose this third option.

The advantage to this option is that by giving the buyer title, you legally separate yourself from liabilities with property maintenance. In option 2, you made the tenant responsible for maintenance, but you still own the property, which means that you are ultimately liable when the tenant makes a bad repair or when someone gets injured on your property. With this third option, you transfer all rights to the property to the tenant which means you have given up your control and you can no longer be liable when the occupant fails to maintain the property for the damage that he or she causes.