Seller financing options

As a bit of a follow up to Ardell’s post below about lease purchase options, another option may be seller financing or a seller carryback.  But, if you choose to go this route how will you handle payments?  One of the best ways to make this less of a burden for the seller is to bring in a third party to handle all of the details associated with servicing the loan terms.

Most traditional transactions with conventional bank financing use an escrow service for handling things such as taxes and insurance.  This is similar but the escrow firm is also handling the servicing of payments, calculating interest and principal payments and such.

An example of a company that provides such a service is Contract Servicing.

Always do your due diligence for any company you will hire, but this might be a good place to learn a bit and find that these services exist for a variety of property contract sales and the myriad ways in which they are negotiated.

92 thoughts on “Seller financing options

  1. Two things to consider.

    1. Due on sale clauses are now enforceable in Washington. I don’t believe that was the case back when seller financing was common.

    2. There are tax implications if the sale would otherwise be exempt as the sale of the primary residence. Unfortunately, I don’t remember what those implications are.

  2. All the more reason to be sure you do your homework before going into one of these. We’ve had a client recently want to buy a house where the seller will possibly go over the $500k capital gains exemption. For them the ability to offer a seller carryback that allows for a payment system so that taxes can be realized only as the payments are received is a good option, especially since they’ll be making interest on those payments and getting a much better rate than they would in a bank savings account.

  3. Another reason to use a third party is if there is an existing loan against the property you want to make sure it is being paid. It would be a real bummer to put down $30,000 make $2,000 payment s for a year and the seller is paying their mortgage and the first mortgage forecloses and you are SOL.

  4. Due on Sale Clauses are definitely something to be aware of however IMNSHO the banks are not going to bother those accounts that are paying on time just a thought.

  5. rob-
    the most a 3rd party will do is let you know that the 1st loan is no longer current, at least you get a warning but that is really about it, then if you are in 2nd pos get first chance at the auction block to buy it back -NOTE WORLD teaches good classes on the subject

  6. Old Guy, you could always bring it current, and just start paying it directly. That’s the advantage of advance notice. Absent advance notice they might be in default 3-4 months before you learn of anything.

  7. Reid, I’d disagree.

    Typically absent a third party, these things are handled one of two ways:

    1. The buyer pays the seller the total payment amount, and the seller forwards on the amount to the pre-existing loans. This leaves the buyer at risk of the seller not paying.

    2. The buyer pays the pre-existing loan directly, and then pays the seller the balance. This leaves the seller at risk of the buyer not paying.

    The third party protects both parties. They were rather common back in the days of real estate contracts.

  8. Rob,

    I have heard that the presence of a 3rd party might “tip off” the underlying lender that there was a sale, and cause them to invoke the due on sale clause. Something to consider. If you are trying to hide the sale from the underlying lender of the seller, introducing a 3rd party to make the mortgage payments could be the event that creates the exception to the rule of “they won’t notice”.

  9. I really don’t think the idea of doing a transaction where your hiding a sale makes a lot of sense, but I’d also question whether you could even do it where the tax payments are escrowed. I’m not sure how connected the tax escrow people are to the lender, but seemingly they’d get some notices indicating a new owner.

  10. The insurance policy is the tip off. When the buyer takes title and gets new insurance the outgoing insurer will send notice of policy cancellation to the lender. The buyer’s new insurer will likewise send notice of the new policy if they’re told of or otherwise learn of the existence of the lien holder.

    Just got a call from another prospective client asking for help with a seller financed purchase. Drafting custom notes and deeds of trust is a little more work but I suspect I’ll be doing more and more of it if the lending rules remain strict.

  11. Yes it is believed that a third party tips off the lender and that could trigger the due on sale.
    Usually what happens it is a result of the old insurance not getting renewed and not the third party. I make the seller keep their insurance the new buyer get their own. As long as the first insurance stays intact it is usually ok. A lot of rental properties use third parties.

    But I am going to stick wit the idea that banks are bothering people that are paying on time. Obviously there is always a chance and as a broker I could not give advice for a buyer to do it. BUT I would do it and have.

  12. Rhonda, I don’t believe it was answered–it’s homeowner’s insurance. Whenever a policy is canceled, the mortgage holders get notice. If they don’t see a replacement, they contact the owner.

  13. Rhonda,

    Kary and Rob are correct. It’s the homewoner’s insurance I was referring to. Like Rob, I suspect many lenders are not in a big hurry to enforce the due on sale clause if the payments are being made on time. But, as an attorney, I cannot prudently advise a client to go forward with a sale without paying off the underlying mortgage(s) or getting the lender’s consent to an assumption or assignment/delegation of the mortgage(s).

    I would love to see some reliable information on which banks are or are not enforcing these clauses but have yet to come across anything.

  14. Marc, even if you came across the information it wouldn’t mean they’d be so forgiving in two years. And what if 90% of the time they aren’t enforcing it? You still couldn’t go ahead with the transaction because you’d be screwed if you were in the 10% category.

    If they were forgiving on this, I’d assume they’d waive the prepayment and allow an assumption. It’s possible that they can’t waive the due on sale clause if the debt is assigned. It’s also possible that they’re required to enforce the due on sale clause if the debt is assigned.

    BTW, as I recall, about 15 years ago there was federal legislation on this, making due on sale clauses enforceable, but allowing states to opt out. Washington didn’t opt out. It’s too bad we didn’t.

  15. Kary,

    I agree, thus, even if I got a call from the CEO of Countrywide (or any other bank) saying they will not enforce due on sale clauses I would still advise my clients that violating the due on sale clause creates risk that the clause would be enforced under a new CEO.

    The point I was making is that I’d like to know, for my own curiosity, what the banks are doing these days in regard to due on sale clauses. I have heard lots of anecdotal comments like Rob’s (i.e., banks aren’t enforcing the clauses on paid-on-time mortgages) but I haven’t heard directly from a person who has explicitly violated their due on sale clause without any adverse result.

  16. Rhonda,

    In most instances, I would describe it as a breach of contract. In Washington, there’s a fairly high threshold for proving fraud. It might rise to the level of fraud if a borrower took out the loan with the actual intent (at the time the loan was created) to transfer the property without lender consent, i.e., an intent to decieve the lender into makingthe loan. If the decision to transfer came after and independently of the obtaining of the loan, breach of contract is a much more likely to be what’s occurred.

  17. Marc,

    I think I agree with that. It is one of the reasons why some escrow firms reject the “creative financing” (whatever that’s supposed to mean…..these things have been going on for years and years) of some transactions.

    Transferring or giving or reducing an interest in a property is not to be taken lightly. It is why it drives escrow people nutty when Quit Claims are used like a light switch: off, on, off , on etc.. never mind the fact that in certain circumstances excise tax is triggered.

  18. I’d agree it’s merely breach of contract. It doesn’t affect their secured position, and no representation is made to the lender at the time of the transfer. I’d have a hard time developing a fraud claim.

    The point is, if they started foreclosure, you’d have only 4 months to pay off the entire debt. If financing wasn’t available at the time of sale, it very well might not be available when the bank learns of the sale.

  19. Would an escrow close a transaction where the seller was financing the sale but not paying off the first that had a due on sale clause?

    Obviously title wouldn’t remove the first from their policy, but would escrow agree to close such a transaction?

  20. #23 Rhonda it is not fraud, it is a default of the contract and the underlying note holder can file a notice of default and invoke the escalation clause. Like Marc said in #25 it would have to have been the intent all along.

    These transactions are called, Subject to, All Inclusive, Wrap Around mortgage. It is not escrows responsibility to enforce the terms of the existing mortgage. They will not release the underlying note that’s for sure.

    I have used wrap around mortgages for a short term fixes. They are not for permanent financing.

    House needs work buyer has 10% down payment but not money for remodeling. Buyer puts 3% down wrapping the new note around the old one, buyer remodels and then refinances into permanent financing. Buyer wound up with an 80% LTV (which he didn’t have before it was fixed up). Seller got rid of a problem and everyone lived happily ever after. All legitimate no fraud.

    Then it would 2-3 months before the bank would file a notice of default and then you have 90 days from that. That is why it is a short term solution.

  21. Rob, you’re apparently in Utah. In Washington it would be 120 days from the notice of default (90 days from Notice of Trustee’s Sale), and they can’t actually hold the sale until the default has existed for 6 months (at least for monetary defaults–maybe there’s an exception for non-monetary ones).

  22. Kary,

    First, I don’t know how enthusiastic Title would be in that situation. They dictate a lot. Second, some escrow firms may close it. Typically, those are the attorneys and escrow firms we read about as case studies.

    As a business owner I prefer to let other people be case studies.

  23. Tim, rather than “case studies” I think the proper term might be “defendants.” 😀

    But that’s what I was trying to figure out–would an escrow have liability for being a participant in such a transaction? I’m not seeing it, but I have seen companies sued for less. I think your cautious attitude is best.

  24. I’m with Tim. Title may not care as much–they’re a issuing a commitment/policy disclosing the underlying mortgage in first position. It is risky business for the escrow company–uncomfortable at the very least.

    How can this not be fraud when you’re purposely having the seller retain home owners insurance in order to not alert the underlying mortgage holder?

    Once the buyer using seller financing (without the underlying mortgage being paid off) good luck!

    From WA State Fannie/Freddie Deed of Trust:

    “If all or any part of the Property or any Interest in the Property is sold or transferred (or if Borrower is not a natural person and a beneficial interest in Borrower is sold or transferred) without Lender’s prior written consent, Lender may require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if such exercise is prohibited by Applicable Law.
    If Lender exercises this option, Lender shall give Borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is given in accordance with Section 15 within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower.”

    I know I don’t need to share this with attorneys, however I’m really concered for RCG readers who might think it’s okay to sell their property without paying off their underlying conventional mortgage.

  25. Reba, is this what your post was about–skirting the underlying mortgage and wrapping mortgages w/tips on not cancelling the home owners insurance? Or were you thinking more along the lines of seller financing w/the underlying mortgage (if any) being paid off/or a new conventional first with a seller carry-back for the second.

  26. Rob said: “and invoke the escalation clause”

    Rob, I think you mean acceleration clause. Other than that comment, I’m not touching this with a ten foot pole.

  27. An additional problem with Rob’s suggestion to have the seller keep paying his/her insurance premium is that the seller’s policy almost certainly provides no coverage. That is to say, if there was a loss the seller’s insurer would verl likely deny coverage because the seller no longer has an insurable interest in the property (because he sold it).

    The buyer’s insurance would hopefully cover the loss but there’s the issue that the buyers are obligated to inform their new insurer of the fact that the property was subject to a mortgage. Doing so creates (in my mind) an unacceptable risk that the new insurer may obtain some basis to deny coverage due to the buyer’s subterfuge.

    Upon learning of the underlying mortgage I would expect the new insurer to send notice of the new policy to the lender who should then take notice of the fact that the person insured by the policy no longer matches the person listed on the loan.

  28. Although probably not in the spirit of Reba’s post, the type of financing people are talking about in the later part of the thread poses lots of legal problems.

    These are THE PROBLEMS that the real estate investment guru’s fail to discuss at their seminars and on their $1,500 tapes/cd’s and weekend warrior “retreats” that are worth about 15 minutes of your time on Google doing a modest amount of research.

    The motivation for doing these types of transactions vary, but mostly are centered around a home that is over leveraged, having a tough time selling and the seller/”investor” needs to have some other “sucker” carry their mortgage.

    But that’s just my two cents worth.

  29. Tim, your 2 cents far outweighs the $1500 spent on a seminar/tape/cd. Guru’s (including the one’s promoting loan mod’s to LOs/Agents) are only here to sell their tapes/cds/memberships….they don’t care a rat’s patooty of what happens after they’ve made their dough.

  30. Marc says, “as an attorney, I cannot prudently advise a client to go forward with a sale without paying off the underlying mortgage(s) or getting the lender’s consent to an assumption or assignment/delegation of the mortgage(s).”

    That’s all it takes for me. Buyers, sellers: Hire your own legal counsel before embarking on this journey.

    Marc also says, “I would love to see some reliable information on which banks are or are not enforcing these clauses but have yet to come across anything.”

    LOL. Banks are not going to let that information get out.

    Another problem that has already been mentioned; I’d be hard pressed to come up with the name of any reputable escrow firm that would take on this transaction. All the more reason to have separate legal counsel for both sides.

  31. Jillayne, in my blog piece in P-I land on getting an attorney/accountant for these unusual transactions, about the only thing I took a position on was that an attorney would be unlikely to recommend going forward with a transaction that violated a due on sale clause. That was mainly purposeful, because I didn’t want to be giving legal advice, but that seems like a no-brainer. Contract says you can’t do it–don’t do it. Contract says your seller can’t do it–don’t do it.

  32. Kary,

    I agree. It wasn’t that the transaction is easily understood and without legal landmines, it’s that the guru’s leave out the pitfalls.

  33. Rhonda, to answer your question in #35, I was absolutely bringing this up from the standpoint of a seller carryback with the first paid off or if the seller owns outright. Of course, I would never suggest anything that could go in the direction that some of these posts have gone. We frequently have to remind investment clients that if they’re buying a property using their personal info/credit, that they need to be careful if they put the property into an LLC that it doesn’t perhaps trigger a due on sale clause. Many people don’t realize that these things exist even if though they’ve signed the documents. It’s not a topic that is covered well in escrow and most lay people don’t realize what it is or means.

  34. I’m probably more bothered by this kind of risk of potential fraud or calling the loan than most, but I’m surprised at how much discussion there was of how to keep the sale from the lender. Personally, I wouldn’t proceed with a seller wrap (which I am looking into doing) without a written letter from the lender saying they are okay with the transfer. No letter, no transaction. Period.

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