By Scott W. Hyder
My client, having tried to sell his home for over a year, smilingly described his potentially great deal. Conventional financing being unavailable, the prospective buyer agreed to a "carry-back" sale: the seller would be the lender. The buyer would pay a down payment and monthly payments on the loan amount at 8% interest, with a balloon payment of principal due in seven years. The seller imagined making 8% interest, and in the worst-case scenario of buyer default, he could get the house back. Sounds great, right?
Maybe — had the seller considered the downsides? First, the seller himself still owed $250,000 on the house. Second, the seller still risked foreclosure if he defaulted on his loan — having owner-financed the buyer did not protect him. The wonderful deal now looks much more complicated.
Seller financing can be a good idea in some cases, if the seller understands the risks. Many sellers would desperately like to sell their homes as in the good old "lender financed/booming market" days, but the realities of this challenging market make selling much more difficult now.
Seller "carry-back" financing offers a creative alternative that can appeal to both sellers and buyers. In a typical carry-back, the property seller accepts from the buyer a down payment and monthly payments of principal and interest, with a balloon payment due at later date. If payments stop or the buyer otherwise defaults under the agreement, then the seller can foreclose (like any typical lender) and repossess the property.
Carry-back deals can present complications. The seller who still has loans on the property must still comply with all loan terms or face foreclosure for default — regardless of whether the new buyer holds title. Also, most commercial loans have a "due on sale" requirement prohibiting or restricting the owner from selling the home without the lender's consent while the loan is still in place. Depending on the circumstances, a commercial lender may give permission; occasionally a seller decides to ignore the requirement and assume the risk.
The buyer in a carry-back deal faces risks, too. Even if the buyer makes timely payments, the seller could abscond with the money to Jamaica, conveniently forgetting to pay the lender. No government "bailout" addresses trips to Jamaica, so the seller's existing lender could foreclose on the new buyer's property.
To protect against that risk, the prospective buyer in a carry-back deal should make sure the seller's commercial loan is paid as required also. One solution is an escrow: the new buyer pays into an escrow instead of directly to the seller. The escrow agent would first pay the seller's existing loan payment and then forward any remaining amount to the seller.
In any carry-back deal, the seller faces the risk having to foreclose if the buyer defaults. Like a typical lender, the seller would have to go through the entire foreclosure process. If the buyer retaliates or has simply not maintained the property, the seller may end up repossessing a property in poor condition. Homeowner insurance can provide some protection if the seller is named as an additional insured on the buyer's policy.
As would any prudent lender, the seller should take necessary precautions and investigate the prospective buyer to determine the risk. This means obtaining consent forms and reviewing tax returns, pay stubs, credit reports, banking accounts, criminal records and so on.
An alternative to the carry-back sale is the "lease-purchase" deal: the tenant-buyer occupies and pays rent with an exclusive option to purchase the home at a later date at a stated price. Such deals can work, but there are legal and business risks to recognize, and the landlord-seller must comply with all landlord-tenant laws, such as the Arizona Residential Landlord and Tenant Act.
Creative transaction structuring takes time and money. Normally, buyers pay these costs as "closing costs" in a typical lender-financed sale. Although carry-back sellers could require buyers to pay these costs, a buyer in dire straights likely has only enough money for the down payment. The costs could thus be "rolled in" to the total loan amount.
Remember: Most agents, brokers and title companies lack the qualifications to properly advise the participants about the issues and risks. Sellers especially should consult an attorney experienced with secured real estate transactions. The attorney can assist with background checks, due diligence, and drafting and recording the documents. The business and legal risks, including the agent's and broker's liability, could be enormous if anything goes wrong. Proceed with caution.
© Scott W. Hyder, 2008. Scott Hyder is an attorney in Phoenix. You can reach him at 602-923-7370 or scott.hyder@cox.net or visit his scott.hyder@cox.net or visit his website.
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