A student did her first complete rehab and got a rude surprise virtually at the closing table.  It seems the lender who approved the well-qualified buyer who had a 20% deposit suddenly asked the student for the expenses associated with the rehab.  This lender suddenly decided to use “FNMA Guidelines” on the amount of profit an investor could make in a specified time even though the loan was not to be insured by FNMA.  The deal died at the closing table.

In this case the student got a good buy on a three bedroom two bath home with a pool.  Her cost was $85,000 and she did a great rehab including her own sweat equity which wasn’t counted in her $25,000 of rehab expenses.  The entire rehab took 45 days and she found a buyer in another 10 days.  FNMA guidelines are that the profit on a resale can be 20% above the purchase price in the first 90 days and after 90 days, there is no limit on the amount of profit the seller can make.

 The student sold the property to a conventional buyer which meant the buyer was borrowing the amount he needed to buy the home from a commercial bank.  She had cash buyers who were will to pay $160,000 but the conventional buyer really wanted the property and his offer was $164,000 so she went with him as the buyer.  The lender got two appraisals which both came in above $165,000.

The estimated profit before closing costs was $164,000 – $85,000 – $25,000 – $5,000 cost of hard money and carrying costs) = $49,000.  This was a good deal and she deserved it – the American Dream in action!  However, along came the conventional lender’s processor earning $15/hour that makes a decision to go to FNMA guidelines the day of the closing and literally minutes before the actual closing was to take place.  All the loan documents and closing documents had been approved.  Was it because the processor realized what “profit” there was in the deal and that she makes less money in a whole year?  Don’t know and never will know but “It Doesn’t Matter!”

The option was to send in the expenses for the project and see what happened but the loan processor always knows that 20% of the purchase price is $85,000 x 20% = $17,000 which would limit the sale price to $102,000.  If you allocate expenses into the price mix then the real cost would be $85,000 + $25,000 = $110,000 x 20% = $22,000 for a new total of $110,000 + $22,000 = $132,000.  Looks better but that isn’t what the guideline stipulates and she is still $32,000 over her “profit limit”!

So the option she had was to cancel the sale and go with a cash buyer – right? Actually the answer is “No” if the seller was FNMA originally because their guideline would be in place for a 20% profit in the first 90 days.  If FNMA was the seller originally, and she got a cash buyer, she would still have violated their guidelines.

If FNMA had been the seller, she could have “flipped” the property to a partner buyer for less than a 20% profit, let’s say she sold it for $100,000 or a profit of $100,000 – $85,000 = $15,000 or a percentage profit of $15,000/$85,000 = 17.64%.  Then she and her partner would do the rehab and she followed FNMA guidelines of selling for a 20% or less profit in the first 90 days.  Her partner and new owner is now able to sell at will as the original deed restriction has been extinguished.

Her other option if the seller was not FNMA was to control the mortgage broker instead of allowing the buyer to use his own mortgage broker.  Often mortgage brokers are so eager to get the business they overlook the obvious such as this deed restriction or lender profit allowable issue.  I’m not sure if the buyer’s mortgage broker expected all would be OK or he just didn’t know what he was doing.  A simple call to his underwriter would have made the difference between an exploded deal where the buyer loses and the mortgage broker gets nothing and everyone coming out happy.

In summary, the property was sold and she made her profit but it was a lesson that we have seen all too often.  Don’t assume that because a mortgage broker seems to know what he is talking about that it is factual – assumptions can be deal killers and very expensive lessons.  It is human nature to trust the pros but it never hurts to double check their work when you can.

To your limitless success,

Dave Dinkel