Question: We placed our home for sale and now an offer has come in: The buyer wants a seller-financed transaction, one where we would take back the mortgage. What are the advantages and pitfalls if we accept this offer?
Answer: Seller take-backs have been with us for as long as real estate has been sold. This is not a new idea but it’s an approach which raises certain questions.
Is the property now financed? If there is an existing mortgage on the property, how will it be paid off if you finance the sale?
In some cases, home buyers envision seller financing to mean that the owner will continue to make payments on the original mortgage and that new financing will be secured with additional debt, a so-called wraparound mortgage.
As an example, imagine that you now have a $250,000 mortgage balance at 4 percent on your home and the property sells for $300,000. The buyer might put down $10,000, so you will take back $40,000 in second-lien financing and you will also continue to make payments on the original mortgage.
No one will ask the lender for permission to assume the $250,000 loan.
You will charge the buyer 4.5 percent for financing, meaning you will get a half percent premium on the $250,000 mortgage balance plus 4.5 percent on the additional $40,000 in financing.
Such transactions involve a lot of risk – for the seller.
First, mortgages routinely have what is called a due on sale or acceleration clause. A lender might demand immediate repayment of the $250,000 arguing – strongly – that the residence has been constructively sold even though you continue to make payments.
Second, you have now sold the property and have $10,000 in hand. Is that enough to acquire a replacement property? Move? How much of the $10,000 will be needed for closing? If you need more cash from the transaction a seller take-back won’t work.
Third, what happens if the buyer doesn’t make payments six months from now? The $250,000 mortgage is an agreement between the seller and the lender. If payments aren’t made the owner’s credit will be hurt.
The seller with a take-back has the ability to foreclose if the buyer does not make required payments.
However, it’s not as simple as it sounds. The seller will need a lawyer to file the appropriate paperwork. The court system can be very slow – and lawyers are expensive.
If the matter does get to court and the property is foreclosed, all the money from the property’s sale will go first to the original lender. Only after the entire balance has and been repaid will any remaining money be given to the holder of the second lien, the seller in this case. If the property sells at auction for $249,000, there won’t be a dime for the seller who took back financing in our example.
Fourth, why is a seller take-back necessary? As this is written, mortgage rates are around 4 percent, an historically-low interest level. Is there some reason the buyer cannot get lender financing? Could there be a credit problem? Even if there is no mortgage on the property why do you want to extend credit to someone who can’t get a bank loan?
Fifth, if the buyer can get a lender mortgage then the sale process is very simple: At closing you get paid and the purchaser gets the property. The sale agreement used by local real estate brokers will work very nicely to help both buyer and seller. Any existing mortgage on the property will be paid off, and if the sale price is sufficient you’ll get a check at closing.
What you won’t get is an obligation to be involved with the property – or the lender – after settlement. Potential liabilities associated with seller take-backs will be gone. You’ll be out.
In all cases involving seller take-backs it’s smart to speak with a real estate attorney before signing anything. It’s also smart – if a seller take-back is of interest — to require credit reports and past tax returns that can be reviewed by the financial professional of your choosing as well as a large cash down payment, sale forms, and a mortgage note satisfactory to your attorney.