When a would-be home buyer can't convince a bank to lend him enough money for a mortgage, the seller may step in to help. In a vendor holdback or take-back mortgage, the vendor -- the seller -- holds back some of his interest in the property by financing part of the purchase. This alternative method of financing does have some risks.
How It Works
With a holdback mortgage, a seller agrees to loan the buyer some or all of the purchase price. The buyer then pays off the debt in monthly installments, just as she would with a bank mortgage. If the seller isn't willing to underwrite a complete home loan, the buyer can take out a mortgage from the bank for most of the purchase price. The seller then takes out a second mortgage to cover the rest of the purchase.
While a bank loan officer has a boss to answer to, the home vendor can make his own deals. The vendor can offer the home buyer a mortgage a bank might consider too great of a credit risk. He also doesn't have to charge all the closing costs a commercial lender does. As the vendor is offering a better deal than the bank, he usually requires a higher sale price in return. Holding back a second mortgage can help out a buyer who can't come up with a large down payment. With any seller financing arrangement, the seller gets some or all of the interest that normally goes to the bank.
A holdback mortgage is a good deal for the buyer if all the terms are acceptable. All of the risks belong to the seller. With a commercial loan, she'd get paid at the closing; with one of these loans, she has to wait several years before she gets the full mortgage amount. If the buyer defaults, the seller loses the rest of the promised payment and has to re-sell the house. The seller has less money at risk if there's a second mortgage, but, if the bank forecloses, the house may not sell for enough to pay anything on that extra mortgage.
Even if the vendor covers the buyer's down payment with a holdback mortgage, that doesn't mean the bank will go along with the deal. Commercial lenders prefer buyers to put down at least 20 percent of the purchase price so they have some skin in the game. They also hate it when buyers have heavy debts besides the first mortgage. A seller-financed second mortgage may make the house more affordable, but it may convince the lender to turn the buyer down.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.