In a reverse exchange, the investor must purchase a property before they have the proceeds from the sale of their relinquished property. This can be a challenge because most investors rely on the proceeds from their relinquished property to buy their replacement property. For this reason, financing becomes an important consideration. So let’s look at how financing typically works in a reverse exchange.
The most common type of reverse exchange, and the most favorable in terms of obtaining financing is the front-leg reverse exchange. In this situation the exchange accommodation title-holder (EAT) takes title to your relinquished property, which then allows you to immediately purchase your new replacement property. In this situation you will likely get a loan to purchase your replacement property. This loan will be guaranteed by you and secured by the replacement property. The lender often will take a security interest in your relinquished property as well. They do this to keep you committed to completing the exchange process and actually selling your replacement property when the time comes. This can be beneficial to you, because the lender will take the equity and loan values of both properties into consideration when they analyze the loan. In some cases, using both properties as collateral allows you to obtain 100% financing to purchase your replacement property. This is obviously very valuable to an investor who can’t afford a down payment until they sell their relinquished property.
If the lender is unwilling to collateralize both properties, the investor needs to come up with the down payment to purchase the replacement property. If you can afford to do this, it can be beneficial because you may qualify to get a typical mortgage on the new property. This could mean less complications in the lending process as well as better loan terms.
In any case many banks are unwilling to lend on these types of transactions due to a lack of understanding of the reverse exchange process and a perceived increase in risk. For more information on how to find a lender willing to provide financing, contact one of our 1031 experts today!
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