Seller carry back financing seems to be a hot idea lately - there’s a lot of folks throwing the concept around. It is a highly misunderstood and sometimes confusing topic.
A Seller carry back is basically when the seller is the lender - the seller typically has a lot of equity in their house, and a Buyer has a big enough down payment to cover the balance of the existing mortgage. The Seller can then sell their house to the Buyer, pay off the existing loan with the down payment money, and then carry back a loan from the Buyer, where the Seller gets paid according to the terms of the loan they make with the Buyer.
The seller can also potentially carry back a second loan on the property - in this case, the Buyer would get a traditional first loan from a lending institution, and the Seller would carry a smaller second loan. First you have to find a traditional lender that will allow a seller carried second this in the current lending market, which is a different story. Let’s just keep this theoretical.
In Arizona, the Seller would take a trust deed and note - a regular loan just like a bank, with all the rights of foreclosure and whatnot.
Also - please note that with carry back financing, the deed changes hands. The Seller no longer owns the property. He sells it. The Buyer gets the deed at the time of the sale.
So. Let’s look at this in broad overview.
Let’s say the Buyer purchases a house for $400,000, just to use some round numbers here. He gets a $300,000 loan from a bank, a $50,000 carry-back from the Seller, and puts down $50,000 as a down payment. The Bank has the 1st lien, the superior position. The Seller has the 2nd lien, the junior position.
Scenario One: The Buyer is happy, healthy, and wise and makes all of his loan payments as scheduled.
Excellent! The Seller is paid interest on his former equity, both Buyer and Seller are happy with the arrangement, every one lives happily ever after.
Scenario Two: The Buyer pays his first loan, but stops paying the Seller’s second loan.
All is not well. As a second lien holder, the Seller can foreclose. Here’s where people get confused. Foreclosure doesn’t mean you get to take back the property. Foreclosure ends with an auction, where you may or may not be the high bidder. Plus, the high bidder has to satisfy the first loan, or take it subject to the first loan. Who ever is in first place - doesn’t go away.
Scenario Three: The Buyer stops making payments to both you and the bank.
Now you’re in real trouble as the second lien holder, especially if the market value has dropped. The person with priority is the bank, and if they begin foreclosure proceedings, you can either cure the first guy’s default and foreclose yourself, or you roll along with their foreclosure, hope there’s enough proceeds at the auction for you to get something out of it. Because if the high bid at the auction only covers the first loan, you walk away with nada.
Seller carry backs are usually highly misunderstood, and if you find yourself considering carry back financing, either as seller or buyer, it’s a good idea to get some professional legal and tax advice. Please also note that there are a multitude of options and ‘other things’ that can happen with these scenarios that are not discussed here. If you find yourself in one of these positions, you need to go get your own legal and tax advice.
