Restricted Sale Property: Very Difficult to Find A Loan

This is a warning to those who purchase restricted sale property. I've gotten a couple of calls for refinancing these in the past couple months, and I've never covered this subject.

A restricted sale property is one where the identity of who can buy it and/or at what price they can buy it is restricted. Many local first time buyer programs restrict the conditions under which the property can be sold. The purchaser must be someone who has themselves qualified for their first time buyer program, the purchase price cannot be above the original purchase price plus a certain margin (usually reflecting a given percentage of Average Median Income for a given Metropolitan Statistical Area), or both.

These are by no means the only restricted sale programs. Many academic institutions have such property upon the grounds of their original endowment. There is a covenant which runs with the land that only faculty members or employees of the college or academy are allowed to purchase the property. I'm sure there are business employee restrictions and others.

This is a classic "good news - bad news" situation. At purchase, it's good news (mostly) because you typically get a far lower price than other, equivalent property, meaning you can afford it when you couldn't otherwise. At sale, however, it means you can't sell for a true market price because either the general public is prohibited from buying or the sales price is restricted by the bargain you made in order to purchase.

What this means is that if lenders have to foreclose upon such a property, they are pretty much up the creek. Such a property is unlikely to sell at auction, they can't just hire an agent and put it on MLS. If the property got beat up before the foreclosure (as happens quite often), it may not be something any of those eligible to purchase it are interested in.

Since it's not generally marketable, most lenders don't want to touch restricted sale properties. This means your loan choices are going to be restricted from the day you sign the purchase contract on. You will probably not be able to get a purchase money loan with most financial institutions. You almost certainly won't be able to refinance on favorable terms, even if everyone who bought without such a restriction can.

Typically, there are only one or two financial institutions willing to touch such a property, and only through their own internal loan officers rather than through any brokers they may do business with. What's going on is that the restricted sale entity (usually a municipality or educational institution) has contracted with them to somehow take care of the problem if there is a foreclosure. This usually takes the form of taking over the property themselves and buying out the lender's Note.

For refinances, all of the above applies, even more strongly because one lender already has the indemnity contract; any others that you might have been able to choose between do not. This means your choices are limited to "refinance with that lender or not at all". Not a good situation to be in as regards to getting a good rate for a reasonable cost. Whatever they feel like offering you is what you get. Nor do you get the standard rates everyone else gets from that lender. You're not in the same situation as everyone else. You're in a special program where nobody else can lend to you because your property cannot be sold to the general public. You're almost certainly stuck with that one lender. It's not like you can go somewhere else.

Due to this lack of competition, expect the rates on loans for such properties to be above market average. Some are fairly close, but it seems an average of half to three quarters of a percent higher on the rate is what you're going to pay when you finance such a property. Furthermore, the only ones able to refinance may be the current lender, as nobody else has that indemnity contract from the restricted sale entity. Lender's don't want to take over your property - they want the loan to be repaid. But they must be able to take over your property and sell it on the market for a market price in order to accept your loan. Anything else is a violation of their duty to their stockholders and bondholders, as well as a violation of federal banking regulations. Since they can't do this, it shouldn't surprise anyone that most lenders can't touch a restricted sale property.

Caveat Emptor

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