In many areas, anyone who’s tried to purchase a home recently knows the pain of the supply shortage. Housing inventory is down and prices are up nationwide. In expensive markets, like San Jose, Los Angeles and Seattle, the competition can be fierce. Cash buyers are pushing out loan-dependent bidders, inspiring buyers to find creative ways to make the strongest offers.
That’s where delayed financing comes in. This financing method allows buyers to use cash, and in some cases stocks, to buy a house and obtain a mortgage after the home is purchased. Essentially, they’re enjoying the advantages of being a cash buyer, while later extracting their cash for a loan and avoiding refinance fees.
The application process for delayed financing is just like applying for a home loan. The borrower needs to supply the same financial information, proof of employment and undergo a credit check. Like a loan prequalification, borrowers must maintain the integrity of their credit and employment status between the time they buy the house and when they get their mortgage.
This type of financing isn’t for everybody and having a pocketful of cash can have its temptations for some people.
“One of the risks, and this is just human nature, is that you want to make that home your own. You want to buy furniture and those types of things. So, there is a risk they advance additional credit to make changes to the home,” says Allen Seelenbinder, divisional sales executive for Bank of America. “So, we just advise them to understand their debt-to-income ratio and credit report.”
What kind of buyers are best suited to delayed financing?
Candidates for delayed financing have access to cash or stocks and a trusted set of advisors. Ideally, buyers would have a conversation with a qualified loan officer, their financial advisor, and attorney or real estate agent about using this product. It’s important to understand the goals and risks of delayed financing.
“It’s an option, not a necessity, and it can be a big benefit for the right clients,” says Seelenbinder.
Along with liquid assets, buyers can leverage securities for delayed financing, Seelenbinder points out. Merrill Lynch, for example, allows buyers to take out a line of credit against their securities. There’s no capital gains tax, because they’re not liquidating them. That line of credit can fund the next day.
“We have clients who purchase a home for $1 million with securities-based lending, come back to us and we do a delayed financing at a percentage of that purchase price, and it pays off their credit line and they get a fixed rate under the same conditions as if they did a purchase transaction,” Seelenbinder says. “And they’re not hit with the additional fees as they would be with a cash-out refinance.”
However, some clients make the mistake of liquidating their assets, which could end up costing them a bundle in taxes. One common example, says Seelenbinder, are heirs who inherit a significant stocks and stock grants. These often have a low cost basis – which is the original value of an asset for tax purposes.
“Once they sell those at current market price then that capital gain becomes a taxable event. If they use that cash to purchase the home, then yes we could do delayed financing to get the cash back; however it could actually cost them more,” Seelendbinder says. “In most cases, there are other avenues for them to avoid or diminish those tax consequences, and a CPA or lawyer would be able to advise them on that.”
Pros and cons of delayed financing
Unlike a cash-out refinance, there’s no six-month title-seasoning wait period, a requirement before lenders will write a mortgage on a newly purchased property. This means buyers are able to get their cash back quickly and lock in a rate. There are no cash-out refinance fees, which can be between 3 and 6 percent of the mortgage.
The downside of this is that if homebuyers wait too long to secure a mortgage after they buy the house through delayed financing, they may face higher interest rates. In today’s rising-rate environment, this is a possibility.
“When you’re talking about bigger loans, an eighth or a quarter of a percentage point rate hike can be significant,” says Ben Dunbar, investment advisor at Gerber Kawasaki Wealth and Investment Management in Santa Monica, California.
Cash buyers also sidestep lender requirements. For example, clients can buy a home that doesn’t pass inspection, fix it up within 60 days, and still qualify for their mortgage. This is common for people in certain areas of the country, especially along the coasts and in vacation spots, says Seelenbinder.
However, buying a home that’s not eligible for financing because of its condition can become a financial disaster.
“It’s a little worrisome that people will buy a house with major damage or structural problems with cash, hoping to get a mortgage later. Unless they hire experts to inspect the house, they really don’t know what they’re buying,” says Dunbar.
In that situation it’s essential to hire inspectors who are specialists, for example in construction or electrical work, to do a thorough evaluation. The worst-case scenario is buying a property, finding the problems are worse than you realized, and then pouring in more cash to remedy them. Worse still, if you can’t afford the repairs, you might not get the delayed financing and you lose access to your cash.
Finally, delayed financing helps homebuyers in tight markets successfully compete for houses because they’re using cash.
“When sellers are looking at 15 offers on their house, you want to make the most attractive offer. This is why we’re seeing more people using delayed financing,” Seelenbinder says.
Although cash buyers are not required to purchase title insurance, it’s a good idea. One reason is that title insurance will detect any undiscovered liens. Another is the peace of mind knowing that in the rare situation where there’s a defect in the title, your investment in the home is protected.
Anyone who’s considering delayed financing should talk to their financial advisor and real estate agent to assess the risks and benefits.