Can a Seller Allow a Buyer to Owe Money Upon the Closing of a Home?

Getting the seller to carry a secondary note is a creative way to finance a home purchase.
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In real estate jargon, buyers owing money at a closing is commonly referred to as the seller "taking back" a second mortgage. When buyers cannot obtain conventional mortgage financing, it can hasten the sale and increase the selling price, particularly in tight credit markets. Seller take-backs are not without risk, however — something of which both sellers and buyers should be aware.

How the Seller Take-Back Works

Imagine a house for sale with an asking price of $200,000 and an appraised value of $190,000. The seller's outstanding mortgage is $100,000. Therefore the seller's equity in the property is $90,000. The buyer is able to obtain conventional mortgage financing for 80 percent of the appraised value ($152,000), but is unable to get financing for 80 percent of the asking price ($160,000). Because the seller has $90,000 in equity in the house, the seller can afford to, and prefers to, "take back" a second mortgage for $10,000. This helps the buyer qualify for conventional financing on the appraised value.

In this scenario, the buyer and seller generate a promissory note for the $10,000 second mortgage with a second lien on the house as collateral. The second lien is subordinate to the first mortgage lien of $152,000.

Seller Take-Back Risks

Before taking back a secondary note, conduct the appropriate due diligence on the borrower, including getting copies of the borrower's credit report and tax returns. Because this is a legal transaction, the promissory note and second deed of trust (lien) must be executed according to terms that will stand up in court. Have an experienced real estate lawyer draw up the papers. Acquaint yourself with the non-judicial foreclosure anti-deficiency laws of your state. These laws bar creditors in non-judicial foreclosures from suing borrowers to recover losses in the event a foreclosure sale was deficient in compensating a second lien and unsecured creditors. In a non-judicial foreclosure, the first mortgage holder can simply foreclose after proper notifications to the borrower without the need for court approval. Again, consult with a real estate lawyer to minimize the risk of loss.

Sell the Second Mortgage

Many sellers are unwilling to hold the second mortgage to maturity, which can be three to seven years. In this case, selling the second mortgage note in the secondary market might be a viable option. Many companies either buy second mortgages outright or act as middlemen in finding buyers for your note. It's smart to shop around and get quotes because discount rates can vary widely by company. Companies that buy, or assist in selling, structured settlements frequently do the same for mortgage notes.

Buyer Take-Back Risk

The major risk to the buyer is default. Failure to adequately budget for the secondary note payments can be a budget buster. That's why it's vital to set your budget first. Then, negotiate with the seller to structure the note so it agrees with your ability to pay. It's also prudent to consult with a real estate lawyer to assure the promissory note conforms to lending laws in your state. Some states exempt seller mortgage note interest rates from usury laws because no cash actually changes hands. You want to avoid paying a usurious interest rate, which can be financially crippling.

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