Seller carry-back loans have been growing in popularity since mortgage companies have tightened the noose on potential borrowers. As even some of the most creditworthy applicants are being turned away by mortgage giants and banks, seller carry-back loans are once again becoming a realistic alternative to traditional mortgages. Seller financing made up 1.3 percent of sales in California last year, up from 0.4 percent in 2007, according to a survey of members of the California Association of Realtors (CAR). That’s a fair increase over two years, but it could be so much more.
There is a huge pool of buyers out there that could benefit from the carry-back loan, but have not been approached with the idea because agents either do not believe in it or they just don’t understand it. Buyers are losing a chance to purchase a home, sellers are losing a chance to sell and agents are losing out on business.
By properly utilizing and understanding the carry-back loan, everyone can be a winner. However, before that can happen, all parties need to understand the risks involved, and more importantly, how to reduce those risks and even sometimes eliminate them by hiring a professional loan servicing company.
Seller risks
►The biggest risk for the seller is the potential for the buyer to default on the loan. The reason most buyers are in the market for a carry-back transaction is because they are unable to obtain a mortgage through traditional means. Often, their credit scores are low and they have a limited amount of income and credit.
►Seller carry-back loans are often second position or junior liens. The buyer’s mortgage with the bank may be in first position and have the first right to any funds obtained through a foreclosure or sale. This means the carry-back loan could be completely wiped out should the property go to foreclosure.
►The seller is not only “The Bank” in the transaction, but also “The Servicer.” The interest, principal and balance of the loan must be tracked and recorded accurately. This can become a huge headache should the Borrower start missing payments or fail to keep the property insurance or taxes current.
►A lack of tools to verify the buyers’ application information can open the doors to fraud. If the buyer is deceiving the seller, there is more of a chance it will go undiscovered until it is too late.
Buyer risks
►If the seller does not own the property free and clear, there is a chance they could default on the senior mortgage, possibly sending the property into foreclosure. Having the payments made by the buyer directed to the senior lien through a bona fide servicer can eliminate this potential problem.
►If the seller decides to finance the buyer for a short period of time, then the buyer will need to refinance at the end of the term and pay off the balance. If the buyer cannot qualify for a refinance, they can be foreclosed on by the seller.
Positives for buyers and sellers
►The buyer is able to get a home despite their credit history.
►The seller can set the demands of the note and establish a monthly cash flow.
►The seller will likely get asking price or better for the property because carry-back loans open the door for more potential buyers.
►Closing time is significantly reduced; a carry-back loan could close in as little as two weeks.
►There can be a tax deferral for the seller when they report under the Installment Sale Method.
►Should the seller ever want a lump sum, they can sell the note to an investor for cash today rather than collect payments over a time period.
►If the buyer does default, the seller could “re-own” the property at the sales price LESS the downpayment. Having intimate knowledge of the property, this could be a risk worth taking.
►Banks are paying very low interest on depositor’s money. A lump sum sale poses the dilemma of where to invest the proceeds: The stock market, more real estate, a savings account? Current interest rates on carry-back loans are very attractive.
How a professional loan servicing company can help
As you may have noticed, most of the risk falls on the seller. But so do most of the rewards. Minimizing the risks, or eliminating them all together, could lead to a very safe and profitable investment for the seller, a new home for the buyer, and a sale that otherwise may have never happened for the agent.
A professional servicing company can offer full document disclosure, review the terms of the loan, service the loan, collect impounds for property taxes, Homeowners Association (HOA) fees and insurance, and even pay the senior lien from the buyer’s monthly payment to assure it is being paid in a timely manner. All of these services help minimize or even extinguish most of the risks involved with a carry-back loan.
Full disclosure is extremely important in today’s economy. More than ever before, lenders have been forced to enforce rights and penalties, which need to be clearly stated and understood by the borrower. Electing to use just a simple note and deed could leave the seller in front of a judge without the necessary proof that they properly disclosed all that they should have … that’s a huge risk.
Employing a professional servicing company not only protects the seller’s investment, it can help structure it, as well. Whether the seller wants to obtain a lump sum in the near future or collect monthly payments for the long term of the loan, a professional servicing company can help strategize the best possible terms of the note and then enforce them. The servicing company can also help find buyers for the note when the seller wants to obtain cash.
What many sellers and agents forget when discussing the possibility of owner financing is the tedious act of actually servicing the loan. The seller is on the hook for accurately calculating interest and principal, keeping track of payment history, issuing federal and state tax forms and many other time-consuming tasks. It’s not just sending a bill and collecting a check.
In fact, part of the reason the seller carry-back loan has developed a bad reputation and has died out in the past is because agents are not around to help the seller figure out what to do when the buyer misses a payment. That would not be an issue with the help of a professional loan servicing company. All of the servicing needs of the loan can be taken care of for as little as $15 per month. The buyer and seller can have a go-to resource for questions for the duration of the loan; and the agent gets positive remarks for a successful transaction.
The revival of owner financing is a second chance for agents to get it right, sellers to take advantage of an opportunity to establish a monthly cash flow, and for buyers who have been denied by the banks to purchase a home. Employing a professional servicing company brings the carry-back loan one step closer to infinite survival.
Drew Louis is president of Del Toro Loan Servicing Inc. He has been successfully servicing loans since 2003 and has more than 20 years of experience in the financial services industry. For more information, call (619) 474-5400 or e-mail
[email protected].
