‘Carry Backs’ Offer Buyer, Seller Benefit
It’s winter, the slowest time of year for home sales. And with thousands of Southland homes languishing for months unsold, many anxious sellers are trying to snare a buyer by offering to provide some of the financing needed to close a deal.
Realtors and other investment experts say that a properly structured seller-financed deal can provide important benefits to both the buyer and the seller.
But buyers and sellers should realize that a deal that’s put together poorly can lead to frustration, lawsuits and even foreclosure.
“Using seller-financing can be a great way for a homeowner to sell a home faster, and a great way for a buyer to get a house that he might not otherwise be able to afford,” said John Tuccillo, chief economist of the National Assn. of Realtors.
“But if the deal isn’t put together properly, it can blow up in somebody’s face.”
The most common form of seller-financing involves the use of a second mortgage--a legal document that realtors typically call a “seller take back” or “seller carry back.”
Say the buyer agrees to purchase the seller’s home for $150,000. The buyer has a down-payment of $15,000, but the bank will lend him only $125,000 because he doesn’t earn enough to qualify for a larger loan.
To close the deal, the seller could agree to “carry back” a second mortgage for the remaining $10,000 in needed financing.
“The buyer benefits because he doesn’t have to make a big down payment, and he’s closing a deal that he otherwise couldn’t get financing for,” said Jack Forness of Century 21/Klowden-Forness Realty in San Diego.
“Meanwhile, the seller is able to get rid of his property, and the interest he’ll collect (on the second mortgage he takes back) will probably be a lot more than he could earn by putting $10,000 in a savings account or money-market fund.”
In a typical carry-back deal, Forness said, the buyer would have to make two mortgage payments each month instead of one. One check would go to the bank that financed the bulk of the transaction, and the second would go to the seller who took back the second.
But one of the beauties of seller-financing, realtors say, is that it gives both the buyer and the seller a chance to tailor the carry back to meet their own special needs.
For example, a seller could offer to take back a second for five years at a 10% annual interest rate. But if the buyer wanted a longer term, the seller could approve a seven-year deal if the buyer agreed to pay a slightly higher rate.
If a seller was particularly eager to sell his home, he might agree to carry back a much larger second at a lower rate.
Or, the seller could even agree to suspend the buyer’s payments on the second mortgage for the first six months or a year after the deal closed. That would leave the buyer with a little extra cash when he first moves in and his budget is tightest.
While the concept of buying and selling real estate with the use of a carry back is relatively simple, there are some potential pitfalls that buyers and sellers alike need to know about.
“From the seller’s standpoint, the biggest thing he needs to worry about is what will happen if the buyer defaults,” said Steve Sokol, an attorney with the California Assn. of Realtors.
“If the buyer quits making payments and some kind of compromise can’t be worked out, the seller might be forced to start foreclosure proceedings. That can be a long and costly process.”
To minimize the chance that the second will fall into foreclosure, Sokol said sellers should have the buyer fill out a standard credit application listing his income, financial obligations and other basic information.
The seller should also check out the buyer’s credit history with the help of TRW or some other credit-reporting agency.
Buyers, meanwhile, should note that many banks and S&Ls; are skittish about being the primary lender in a seller-financed deal. Most lenders will consider the payment on the carry-back when they’re determining how much money the buyer can borrow, and they’ll reduce the amount that they’re willing to lend accordingly.
However, it’s also important to remember that lenders have no industry-wide policy regarding seller-financed deals, said Steve Ashley, a mortgage banker and vice president of the Mortgage Bankers Assn. of America.
“Some lenders won’t touch a deal that involves seller-financing, but others will,” Ashley said.
Often times, a banker’s decision on whether to make the loan will depend on the size of the buyer’s down-payment.
For example, Ashley said, a buyer who makes a big down payment of 50%, wants a bank loan for 40% and is getting a 10% seller-carry-back has a good chance of getting his loan application approved.
But a buyer who’s putting nothing down, getting a 5% carry-back and asking the bank to finance 95% of the deal is “probably going to have a hard time getting a loan,” Ashley said.
“A borrower who makes a big down payment is usually a lot more likely to make his monthly payments than a buyer who doesn’t put anything down, because the borrower who has a lot of his own cash wrapped up in the property stands to lose more if he defaults on the loan.”
Fortunately, buyers and sellers who take part in a seller-financed deal can get help from a variety of professionals.
A good real estate agent can help negotiate terms of the carry back and will usually write up the preliminary contract. The title-insurance company and escrow officer or closing attorney you use will handle most or all of the legal paper work.
But while these and other real estate professionals can help you sew together an airtight deal, you should familiarize yourself with some of the terms you’ll likely hear when putting together a seller-financed transaction.
Here are some items that any homeowner who’s planning to carry back a second should consider:
* Insurance: The seller should insist that his name be added as a “loss-payee” on the buyer’s new home-insurance policy.
If the house burns down or sustains some other type of damage and the seller isn’t listed as a loss-payee on the insurance policy, a dishonest buyer could simply pocket the reimbursement check and leave the seller holding the bag.
* Notice of Delinquency: This notice, typically filed when the second mortgage is recorded at the county recorder’s office, calls for the bank that holds the first mortgage to notify the seller or the seller’s trustee if the buyer falls behind on his payments.
By acting quickly, the seller might be able to work out a deal with the bank or the buyer to avoid a costly foreclosure.
* Notice of Default: Much like the Notice of Delinquency, this requires the bank to notify the seller or the seller’s trustee if the buyer officially defaults on his bank loan.
Although most default notices are triggered because a buyer quits making payments, it can also be activated if he breaches other terms of his mortgage contract--for example, if he doesn’t pay his fire-insurance premiums or lets the property fall into disrepair.
* Tax Service: In a typical seller carry back, the buyer is responsible for paying property taxes on the home. By hiring a tax service, the seller who carried back the second will automatically be notified if the buyer doesn’t pay his taxes.
A tax service is basically an “early warning” system: It lets the seller know that the buyer is in trouble, and may give him the time he needs to work out a deal that will prevent the property from being sold at a tax sale. The title-insurance company or escrow office you use should be able to recommend a tax service, or you can find one by looking under the “Taxes” heading of your local Yellow Pages.
While performing a credit check of the buyer and requesting various types of notices essentially safeguard only the seller, other steps involved in putting together a successful carry-back deal protect both parties.
* Title Insurance: Virtually every real estate transaction involves the use of a title-insurance policy, and deals involving carry backs are no exception.
Although purchasing a title policy accomplishes a variety of objectives, one of the most important is that it ensures that the seller has “clear title” to the home and that there are no outstanding claims against it. In a sense, it “proves” that the seller has the legal right to sell the property.
* Recording: Both the buyer and the seller should insist that the second mortgage that the seller carries back should be recorded with the county recorder or other appropriate agency.
The seller should have the second recorded because it protects his continuing interest in the home. If the second isn’t recorded, claims by other creditors--from lenders to contractors--could be given priority if the seller must eventually foreclose.
One reason why the buyer should insist that the second be recorded is because, if it isn’t, the Internal Revenue Service could challenge the buyer’s deductions for interest payments on the loan.
If the lien against the property isn’t recorded, there’s no sure-fire proof that the payments the buyer made on the loan are tax-deductible “mortgage debt.” Instead, the IRS may argue that the loan is non-deductible “consumer debt” and deny the buyer any write-offs for finance charges.
The California Assn. of Realtors offers a preprinted contract and checklist that both buyers and sellers in the state should examine and complete before entering a seller-financed real estate deal. It’s called a “Seller Financing Disclosure Statement,” or “SFD-14.”
If you’re buying or selling a home with the help of a realtor, your agent should be able to give you an SFD-14 free. If not, you can buy one for about $5 from your local board of realtors or from CAR’s Los Angeles headquarters.
Realtor groups in most other states offer similar forms at little or no cost.
Letters and questions may be sent to Myers at the Real Estate section, Los Angeles Times, Times Mirror Square, Los Angeles 90053. Questions cannot be answered individually. Average Rates for Residential Mortgages Average rates for residential mortgages as of Nov. 29, 1991.
Area 15 Year 30 Year Composite 1 Year Composite National 8.41% 8.81% 8.62% 6.33% 6.63% California 8.53 8.91 8.73 6.26 6.46 Connecticut 8.37 8.80 8.62 6.38 6.61 Wash. D.C. 8.28 8.68 8.50 5.97 6.39 Florida 8.32 8.75 8.55 6.26 6.59 Mass. 8.34 8.78 8.58 6.24 6.76 New Jersey 8.40 8.80 8.61 6.36 6.89 N.Y. Metro 8.45 8.85 8.67 6.41 6.79 New York 8.52 8.92 8.74 6.47 6.76 N.Y. Co-ops 8.60 9.06 8.93 7.03 7.55 Pa. 8.22 8.62 8.43 6.26 6.51 Texas 8.30 8.73 8.52 6.23 6.51
SOURCE: HSH Associates, Butler, N.J.