When a seller carrybacks a mortgage, it means that the seller is holding the mortgage on the property for the buyer, rather than a bank or mortgage lender financing the home. Other terms for it are owner financing and seller financing. Instead of the buyer making mortgage payments to the bank or mortgage company, the buyer makes monthly mortgage payments to the seller.
How It Works
When a seller holds the mortgage on the property they are selling, the buyer and seller of the home negotiate the terms of the financing. The seller can agree to finance the entire purchase price of the home or just a portion of the home. If the seller agrees to financing a portion of the home, then the buyer is responsible for making a down payment to the seller. Once they agree upon the terms and conditions, the buyer and seller can draw up an agreement and a promissory note. The promissory note states the amount of the loan, the interest rate, the monthly payments and the term of the loan.
The buyer signs the promissory note. By signing the note, the buyer agrees that they owe the seller under the terms and conditions set forth in the note. If a seller so chooses, they can record the mortgage or note with the county where the property is. The seller can do this by contacting the County Clerk's Office in the county of the property location.
Terms and Conditions
When it comes to seller financing, everything is negotiated between the buyer and the seller. This includes the:
- Amount of financing
- Term (length of time)
- Interest rate
According to a new provision of the Frank Dodd Act that was passed in 2013, negotiations for seller financing is required by a licensed mortgage originator. The exceptions to this law, however, allow sellers and buyers to negotiate without professional help as long as:
- The seller determines the buyer's ability to pay back the loan. Generally this requires a credit check, as well as employment and income verification.
- The loan is not a balloon payment, which requires the buyer to pay off the lump sum of the mortgage after a certain number of years.
- The interest rate set is a fixed rate for at least five years.
A buyer and/or seller can opt to work with a real estate attorney to draw up the purchase and sale agreement, along with the promissory note. While hiring an attorney requires some outlay of cash, it is still typically a less expensive option than traditional mortgage closing costs.
Seller Advantages
The seller can benefit from holding the mortgage note on the home they are selling.
Maximizes Selling Price
The seller can demand the highest price possible for their home. In some instances, sellers can ask for and receive more than the market value of their home when buyers do not have to go through the typical financing process. Additionally, it cuts out the middle men, such as real estate agents or mortgage originators, that charge fees for buying, selling and financing.
Quick Closing
Buyers and sellers can close on the deal fast and easy with seller financing. The buyer doesn't have to apply for and wait for mortgage processing. Once the buyer and seller negotiate the deal, the closing on the sale and purchase of the home can be set.
Tax Savings
Sellers are required to pay capital gains tax on profits from a home sale. The seller is only required, however, to pay on the amount they receive in a tax year. Since the seller is receiving payments from the buyer rather than one lump sum, the amount of taxes the seller has to pay is reduced.
Seller Risks
As advantageous as carryback mortgages can be, it carries risks for the seller as well.
Default
Buyers can default on the loan; this is especially true if the buyer buys the home for more than the market value. In essence, the buyer starts out with an underwater mortgage - owing more on the home than it is worth.
Buyers can stop making payments or walk away from the home altogether. Either way, this forces the seller to begin foreclosure proceedings in order to recoup their money and the property.
Buyer Advantages
Seller financing can be just as advantageous to a buyer as it can be to a seller.
Easy to Qualify
A seller can run a credit check, verify your employment and ask for income verification documentation. Negotiating with a seller tends to be faster and easier than going through the mortgage qualification process with a bank or mortgage company, which can take weeks or months to accomplish.
Saves Money
A typical mortgage process requires the buyer and seller to pay closing costs on the transaction. These costs can be saved when a buyer and seller enter into seller financing.
Credit Isn't a Problem
Sellers tend to be more lenient than banks and lenders that have strict lending guidelines. Often times, buyers with poor credit or those that have blemishes on their credit can negotiate with a seller, even if they would have a difficult time qualifying for a traditional mortgage.
Buyer Risks
Buyers should take heed when using seller financing as well.
Overpaying
Buyers can expect to pay more for the home than if they were financing the home via traditional channels. While some costs are avoided, such as closing costs, sellers holding the mortgage can ask a premium for the sale of the home.
Bankruptcy
If the seller files for bankruptcy, this can put the buyer's interest in the home at risk. If the home is liquidated in a bankruptcy case, the buyer can lose the money they have already paid on the home. The buyer also loses any future ownership interest in the home.
Default
In a situation where the seller has an existing mortgage on the home, it can also cause a problem for the buyer. If the seller defaults on the loan, foreclosure can be a reality. Again, this puts the buyer's existing investment and future ownership rights in jeopardy.
Take the Good With the Bad
When a seller carries back a mortgage, it can advantageous for both parties. Seller financing also carries its risks. Both parties should know what they are entering into prior to signing on the dotted line.
