Seller Carry Back

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There are times when a buyer interested in a house is not able to obtain financing, in other words, they cannot qualify for a mortgage from a lender. This prevents them from purchasing the house. In this situation, the seller may be willing to offer a seller carry back mortgage, where they provide financing for the buyer, similar to the way banks give out mortgages.

What You Should Know

  • A seller carry back mortgage is a mortgage provided by a seller for a buyer who cannot qualify for a mortgage from a traditional lender, such as a bank or credit union.
  • If the seller has not paid off their initial mortgage yet, they may let the buyer take over the payments and pay the seller the difference between the home price and the remaining mortgage payments
  • The interest rate on seller carry back mortgages is higher than traditional mortgages.
  • Sellers can sell the mortgage to private investors at a discount if they prefer a lump sum payment instead of periodic payments.

What is a Seller Carry Back Mortgage

When a homeowner wants to sell their home, however, buyers cannot get approved for a mortgage, carry back mortgages can be a solution to the problem. With a seller carry back mortgage, the seller takes the role of the bank and provides the buyer with the necessary financing to purchase the house. Instead of making monthly mortgage payments to a bank or credit union, the buyer makes these payments to the seller.

If the seller has an existing mortgage, they may arrange for the buyer to take over the remaining of the mortgage payments and pay them the difference either through a lump sum or through additional payments made to them. The amount the buyer would pay as a loan in this scenario would be calculated as:

House Sale Price
Down Payment that the buyer makes to the seller
Seller's remaining existing loan
Loan that the seller gives to the buyer

How do Seller Carry Back mortgages work?

The process of the seller providing a carry back mortgage to the buyer goes something like this:

Step 1: Buyer and seller agree on a carry back mortgage

When the buyer applies for a mortgage with traditional lenders such as banks or credit unions, and their application is not approved, the buyer may resort to asking the seller directly for financing. In a buyer’s market where there are more houses available for sales than interested buyers, a seller may agree to provide the buyer a carry back mortgage.

Step 2: Seller checks buyer’s creditworthiness

Even though the seller is aware that the buyer got rejected for a mortgage, they still need to know for themselves how reliable the buyer is in paying them back. To do this, the seller may ask for permission to pull the buyer’s credit report, similar to the steps that the banks follow when they provide mortgages. The seller can look at the history of payments by the buyer, if there have been any late payments on past debts or whether they have gone bankrupt. This will give the seller a clearer picture of the buyer’s creditworthiness.

Step 3: Buyer and seller negotiate terms

Once the seller is satisfied with the buyer’s creditworthiness, the terms of the agreement can be negotiated. These include the mortgage rate, the down payment, the term of the loan, and other terms included in regular mortgages. Technically, the seller can ask for as big of a down payment and as high of a mortgage rate as they see fit. The seller may ask for a bigger than usual down payment when they have a mortgage on the property which includes a Due-on-Sale clause. Sometimes, transferring the title of a house can trigger this clause.

What is the Due-on-Sale clause?

Mortgages that contain a Due-on-Sale clause are not assumable. This means that the mortgage cannot be transferred to the new owner if the home is sold. If the homeowner wants to sell the house, they would first need to pay off the remaining balance on the mortgage completely.

The terms can also include what happens in the case that, at some point, the buyer fails to make the payments owed to the seller. In this scenario, the seller can foreclose and take the property back from the buyer.

Step 4: Parties sign a promissory note

After the buyer and seller have come to an agreement on the terms of the arrangement, they sign a promissory note. In the note, the buyer promises to pay an amount of money to the seller at a specific time with an agreed-upon interest rate.

Step 5: Seller moves out and transfers title

The next steps resemble that of a typical mortgage. The seller transfers the title of the property to the buyer and moves out of the house.

Step 6: Buyer makes periodic payments to the seller

Instead of making monthly payments to a traditional lender, the buyer makes mortgage payments to the seller. Just like in a regular mortgage, the seller can declare foreclosure if the buyer fails to hold to their end of the agreement and does not make the payments.

Advantage of Seller Carry Back Mortgages

For Sellers

There are certain perks to sellers who give a carry back mortgage. Some of these include:

  1. Greater pool of buyers - Offering a carry back mortgage widens the pool of potential buyers. This happens because the category of people who would typically not qualify for a regular mortgage, now have another financing alternative. This attracts more buyers to the property, thus increasing the seller’s chances of getting a good deal on the house.
  2. Higher Price - Sellers that offer carry back mortgages typically charge a higher price on the house. The seller is providing the benefit of financing the buyer, taking on some risk, and sacrificing the benefit of having been paid one lump sum altogether.
  3. Better Rate of Return - Sellers can charge as big of an interest rate as they wish on a seller carry back mortgage. This means that they may be able to get a better rate of return than most money market investments.
  4. Additional stream of income - A carry back mortgage provides the seller with additional monthly income since the buyer will have to make periodic payments to pay off the mortgage and the house. Sellers who are not looking to make any big purchases from the house sale proceeds can benefit most from this.
  5. Capital gains taxes - If a homeowner sells their home outright, they will typically have to pay hefty capital gains taxes on the sale. However, with a seller carry back mortgage, sellers can defer some of their capital gains, resulting in lower taxes.

For Buyers

  1. Access to financing - Seller carry back mortgages provide financing to buyers with poor credit who can otherwise not qualify for a traditional mortgage. It provides the opportunity for this category of buyers to become homeowners.
  2. Faster and cheaper closing - With a regular mortgage, a borrower would have to apply for the mortgage, wait for the approval, go through the underwriting and closing procedures. With a carry back mortgage, the borrowers can skip some of the steps and close on the deal faster since fewer people are involved in it. Moreover, there are no bank fees and charges to originating the loan or appraising the house.
  3. Flexible down payment - In a seller-carry back mortgage, everything is negotiable, including the down payment the borrower has to make. Traditional mortgage lenders have minimums and requirements as far as down payments go.
  4. Better interest rate for some buyers - Carry back mortgages are also attractive to buyers who own a number of properties. Banks and other lenders typically charge a significantly higher interest rate to borrowers who own multiple properties. Seller carry back mortgages may offer a better mortgage rate in this case.

Disadvantages of Seller Carry Back Mortgages

For Sellers

  1. Buyer defaults on loan - The biggest disadvantage of carry back mortgages for the seller is the possibility that the buyer may stop making mortgage payments and thus default on the loan. In this case, the seller will have to declare foreclosure and deal with the proceedings of taking back the house, which can be a hassle.
  2. Loss of equity - As in every house sale, the seller will have to incur some of the expenses related to the house sale. These can include the real estate commission paid to the real estate agents and other seller closing costs. In a regular sale, the seller would be able to make up these costs by the proceedings of the sale. However, in a carry back mortgage, if the buyer defaults early on their loan and depending on the down payment made, the seller may experience a loss of equity.
  3. Tied up cash - The seller will not be able to use all the proceedings of the house sale as they typically would if they didn’t provide a carry back mortgage and sold the home outright. Therefore, their money will always be tied up to the property.

For Buyers

  1. Higher interest rate - Borrowers of carry back mortgages will typically have to pay higher interest rates on these mortgages than they would if they were approved of a regular mortgage. Sellers charge higher rates since they are taking on the risk of the buyer defaulting on the loan, and are forgoing their chance to get one lump sum payment from the sale.
  2. Owner forecloses - If the seller of the house has a mortgage on the house with a due-on-sale clause, then they would have to pay up all the mortgage if they want to sell the house. If for any reason, the seller cannot make this payment, the bank may foreclose on the house.
  3. Balloon payments - A seller carry back mortgage may have a balloon payment that is due after 5 or 10 years. If the buyer cannot pay this balloon payment when it is due, they may risk losing the home.

Selling the note

If the seller wants a one-time payment instead of monthly payments by the buyer, they can choose to sell the note to an interested private investor. Private investors purchase carry back mortgages and when they do, they are the ones that collect the monthly payments from the buyer of the property. Typically, the seller sells the note on a discount to the investors. The size of the discount depends on several factors, such as:

  • Interest rate - A carry back mortgage with a higher interest rate is more profitable to the investor. This is why the discount on these mortgages offering high rates may be lower than a similar mortgage with lower interest rate.
  • Mortgage term - Investors typically prefer carry back mortgages with shorter terms. Therefore, mortgages with longer terms have higher discounts.
  • Prepayment penalties and late charges - Mortgages that include prepayment penalties and late charges are more attractive, which is why the discount rate offered is lower.
  • LTV ratio - A mortgage with a lower LTV ratio is less risky and more attractive to investors. Higher discounts are applied to mortgages with higher LTV ratios which are more risky.
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