January 04, 2016
Purchase CEMA: A how-to guide to realize tax savings for all parties
A purchase CEMA can create opportunity and significant value for all sides of a transaction—buyers, sellers, lenders and real estate brokers. While it can take a bit more effort and cooperation from the parties, the incentives and rewards can be large. It even opens up a new marketing tool for attorneys, lenders and brokers who understand how the process works.
Buyers win because they get substantial savings on their mortgage tax. Sellers win because they save on their transfer taxes. Lenders and real estate brokers win because the structure is a great marketing tool to consumers, who stand to save thousands of dollars.
To help you navigate the process and explain it to your clients, we present a primer with hands-on examples below. Of course, you can always call us for help.
In a purchase CEMA, the buyer assumes responsibility for the seller’s existing mortgage on the property, borrows any new money required (i.e., the difference between the outstanding principal on the seller’s mortgage and the amount the buyer actually wants to finance) and then consolidates the two notes and two mortgages into one.
Here is an example:
- Sales price is $1 million
- Seller has existing unpaid principal of $500,000
- Buyer would like to finance $800,000 of the purchase price
- In this case, the buyer will:
- Pay the seller $500,000
- Assume the seller’s $500,000 mortgage
- Obtain a “new money mortgage” for $300,000
- Consolidate the seller’s $500,000 mortgage and the buyer’s new money mortgage into a single $800,000 loan with a new rate and term equivalent to the rate and term they would have received on a standard $800,000 loan.
The seller’s assigned mortgage is consolidated with the buyer’s new mortgage and is extended and modified based on the terms agreed to by the buyer and the buyer’s lender. The new, consolidated, extended, and modified mortgage results in a single lien against the property, with the buyer’s lender as the only mortgagee. The underlying mortgage note is no longer deemed a liability for the seller because it has been modified by the CEMA agreement.
BENEFITS TO ATTORNEYS
As an attorney you can use your expertise in purchase CEMAs to increase both your future business and your revenue per transaction by charging to prepare and pursue the CEMA. To compensate for the additional work involved, attorneys often charge between $400 and $1000 more for purchase CEMA transactions. Moreover, enabling such large savings for your client—particularly if you suggest the structure—can drive a significant increase in referral business and help you to stand out in a competitive legal market in the same way that reducing other closing costs (e.g., title insurance) can set you apart.
BENEFITS TO MORTGAGE LENDERS
A purchase CEMA is a prime marketing opportunity for lenders because it enables you to offer consumers cash savings at a moment when they’re spending huge sums, differentiating your service and product from other lenders and loan officers in the same way that you can use savings on title insurance and other closing costs to do the same. When you review the TRID loan estimate with your customer, you can discuss the potential for a purchase CEMA to dramatically reduce the “Other Costs” line item. Instant savings at the closing table may be more compelling to a cash-strapped borrower than even a few basis points on the rate.
BENEFITS TO THE BUYER
The buyer gets a dramatic reduction in mortgage tax—usually the largest single closing expense. When obtaining a mortgage in New York State, the buyer of a property typically pays mortgage tax on the entire amount of their new mortgage. That mortgage tax in New York State is usually the largest single closing cost and may account for as much as 40% of the closing costs paid in a purchase transaction. The mortgage tax rate in the five boroughs of New York City ranges from 1.8% to 2.55% of the loan.
With a purchase CEMA, however, a buyer is only required to pay the tax on the so-called “new money,” the amount that they borrow in excess of the seller’s outstanding principal balance. In the example above, the buyer will save the entire mortgage tax on $500,000 (the amount of the seller’s unpaid principal balance). While a buyer of a $1 million dollar property taking out an $800,000 mortgage would normally be taxed on the full amount of the loan at a rate of 1.925%, totaling $15,400, if the seller assigns their $500,000 mortgage to the buyer, the buyer only pays taxes on the remainder of the financing—$300,000—reducing the tax bill to $5,775, a savings of $9,625.
Most major lenders consider a purchase CEMA a specialty purchase product that the buyer should ask about as early in the purchasing process as possible. Seller’s existing mortgage is assigned at closing to the buyer and then amended to reflect the terms of the buyer’s new mortgage commitment. Otherwise, the purchase transaction is the same as a transaction without a CEMA.
BENEFITS TO THE SELLER
The seller gets a significant reduction in their New York state transfer taxes in virtually all cases thanks to a “continuing lien reduction.” Moreover, a seller can use their willingness to participate in a CEMA as an incentive to potential buyers either when marketing the property or when trying to close a negotiating gap.
The seller saves a portion of their New York State transfer tax because, rather than the Seller paying transfer tax on the full sale price, the transfer tax is the sale price less the amount of the mortgage assumed by buyer.[i] The New York State transfer tax rate is currently 0.4% of the sales price of a home.
Using the example from above, if the seller assigns his existing $500,000 mortgage on a $1 million property, instead of paying transfer tax on the full sale price (i.e., $1 million), seller only pay taxes on $500,000, or the sale price minus the amount of the mortgage that’s getting assigned to the buyer. State transfer tax amounts to $2 per every $500 of the property’s value. So to calculate seller’s potential savings, seller’s transfer taxes for the final sale will come to $2,000 instead of $4,000—a 50% savings.
A seller can also market their willingness to help with a purchase CEMA as an added incentive to buyers. A seller could contact his lender before a buyer even appears and have all the requisite documents at the ready as a way to make his property more appealing to buyers. The same way a seller might tout his home’s new kitchen or improved heating system, the option to easily conduct a purchase CEMA may be a way to differentiate the property without cutting the listing price. Similarly, the tax savings from a purchase CEMA can help close a deal at the negotiation stage.
For a purchase CEMA to work, the seller needs to have an outstanding mortgage and the buyer needs to be financing the purchase—no all-cash buyers and no sellers who have already paid off their home loan. The property must be a one-to-three family house or single residential condo unit. CEMAs are a non-starter in co-ops because they are not considered real property; mortgage recording tax does not apply, so there is no benefit.
This structure makes the most sense if each party’s mortgage is reasonably large: an unpaid principal balance of approximately $400,000 or more outside of New York City and perhaps as low as $250,000 in New York City (higher New York City tax rates make a smaller CEMA economical). The larger the mortgages involved, the more likely it is that the savings will be greater than the added fees charged by lawyers and banks for handling a purchase CEMA. When loans are small, the numbers often do not make sense.
Most importantly, the buyer’s lender, seller’s lender, and the buyers and sellers themselves must be willing to participate. A buyer cannot force a seller to assign the existing loan but can include a provision in the contract requiring the seller’s cooperation with a CEMA. The purchase CEMA is a proposed modification to an existing contract that seller has already signed and, absent a clause in the purchase agreement with buyer, the seller has no obligation to execute any modification.
A purchase CEMA also requires that certain documentation on the property—called the chain of assignments—is available. If the seller had a CEMA from the prior owner, the seller will need the complete chain of assignments duly executed and recorded in order to support the new mortgage.
Purchase CEMAs do add a complicated layer to the purchase. Because of this, both the seller’s lender and the buyer’s lender as well as the lenders’ attorneys generally add fees. In addition, the buyer’s and seller’s attorneys may also increase their fees to compensate for the additional work involved. The County Clerk’s recording fees for the CEMA documents could be another $300-$500. The total extra costs may add up to a few thousand dollars. A buyer considering a purchase CEMA should speak to the new mortgage lender and acquire an estimated breakdown of the closing costs. Then, the buyer should compare that to the amount of mortgage tax savings.
A buyer contemplating a purchase CEMA should introduce the idea to the seller early on and, if possible, include a written stipulation in the sales contract requiring the seller to cooperate. Between securing information, obtaining permission, and executing additional paperwork for the banks, a CEMA adds approximately six weeks to a deal. Therefore, buyer’s attorney should submit all requests for paperwork, such as the seller’s mortgage file, as soon as a contract is signed.
Some banks will not assign mortgages, which is why a buyer pursuing this course should speak to the seller early on in the discussions and find out the existing lender’s CEMA policies. A safe work-around is for the buyer to use the seller’s lender for the new mortgage.
Not all attorneys will engage in a CEMA transaction, therefore the buyer should ask about purchase CEMAs prior to engaging in an attorney-client relationship. For attorneys who do have the expertise, however, this can be a source of business and can drive referrals. A purchase CEMA is most common in new construction condos where the building’s developer, i.e. the sponsor, sells off portions of the construction loan it used to build the project to buyers. Working with a developer/seller may be easier because a sponsor typically has a legal team in place to handle this more complex transaction financing scheme.
INCENTIVE DURING NEGOTIATIONS
A purchase CEMA is a smart angle to take in transaction negotiations because it’s a way for both parties to cut costs without the seller lowering the price. Since the savings are so much more significant on the buyer’s side, buyers (outside of a condo sponsor purchase) may offer to throw some of the savings back to the seller in order to coax them into a deal. At a minimum, the buyer almost always reimburses the seller for any additional fees they incur.
When it comes to negotiating with a sponsor/developer, buyers often fail to obtain outright price reductions on the condo unit because—since the sale price is publicly recorded—a price reduction effectively sets a new lower price for every unit in that line. Instead, buyers should focus on “off deed” concessions: Payment of buyer’s legal fees, prepayment of common charges for a defined period of time, upgrades to a unit’s finishes and fixtures, roof rights, license to a non-deeded parking space, sponsor covering buyer’s contribution to the reserve fund. A request that the sponsor cooperate with a purchase CEMA certainly belongs on that list.