Tuesday, March 6, 2007

Seller Carrybacks

In this market where homes are sitting with a for sale sign in their yard for longer than the seller would like, many sellers are considering non-traditional offers from buyers that they would not normally consider.  One type of offer that we've seen recently includes the seller carrying back a second mortgage for the buyer.

Here's how it works:  Let's say a seller is asking $300,000 for a home, and the balance on the current mortgage is $200,000.  The buyer can qualify for a new first mortgage of $240,000 (80% Loan to Value), but he doesn't have $60,000 for a down payment, and he can't afford the payment on the high-interest rate second mortgage the bank wants to give him.  So he asks the seller to carryback the remaining $60,000 as a second mortgage at a more reasonable interest rate.

Benefits for the Buyer:  This is obvious - the buyer gets to buy a home with favorable financing, and can have little (or even none) of his own money at risk.  Worst case scenario for him if he has trouble making the mortgage payments is he walks away from the home & starts over, with little or no financial loss.

Benefits for the Seller:  If things go right, the seller is able to sell his home rather than continuing to wait out the slow market, and he'll get to earn interest on the money he's lending the buyer.  He'll also receive monthly payments from the buyer, and eventually get his principal balance back (exacly when and how much will depend on the terms of the mortgage the buyer & seller agree to.)

Risk for the Seller:  There's a chance the buyer will not be able or willing to repay the carryback according to the terms agreed upon.  In this case, the seller will either need to take the property back (if the buyer is curteous enough to offer it back), or to foreclose on the buyer.  If foreclosure is the best option, the seller will have to make mortgage payments on the buyer's first mortgage while the foreclosure process is taking place.  In other words, the seller could have to try to sell the house again, while at the same time making monthly payments on the buyer's first mortgage.

Sellers - Protect Thyself!  The single most important thing the seller can have when offering a carryback is equity in the house.  In the example above, the house was listed for $300,000, but it was sitting on the market.  If the seller wanted to get rid of the house quickly, the list price might need to be lowered to $280,000.  In addition, there are costs involved in foreclosing, as well as accounting for the extra mortgage payments you might have to make - let's assume 3-5% for this example.  A moderate 4% of $280,000 is $11,200 in extra costs.  Add to that the costs of actually selling the home again - your realtor might be sympathetic to your cause & offer to re-list your home for free, but you'll still need to pay the next buyer's broker (3%) plus incur a new set of title fees (1%).  There's another $11,200.  So... $280,000, less $11,200 in extra costs, less $11,200 in selling costs, equals $257,600.  If your seller carryback AND the buyer's new first mortgage total more than $257,600, you're putting yourself at risk for a financial loss.  In addition, the more money the buyer puts into the deal (his own money - cold, hard cash that he owns), the more he is going to try to keep everything together before walking away.

Do seller carrybacks have a place in today's market?  Absolutely!  If done right they can help you sell your home and create an income stream which earns you interest.  But they're not for the uneducated or the faint of heart.  And there's a reason the banks have criteria in place and charge higher interest rates - more risk!

-Chris