Owner Carryback Mortgages

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 What is an “Owner Carry-back Mortgage”?

An owner carry-back mortgage is a mortgage loan provided by the owner of a house to a person who buys the house. The owner/seller of the property is said to “carry” the mortgage loan for the borrower/buyer.

Owner carry-back arrangements are often used as a last resort when a person who wants to buy real property cannot otherwise qualify for a mortgage loan. This type of loan is also known as “owner financing.” Of course, it involves a seller who is in a financial position to provide a mortgage loan to a buyer for part or all of the selling price.

Owners willing to finance the purchase of property they own usually do not finance the entire purchase price, as is the case with commercial lenders. Commercial lenders usually require a down payment of part of the purchase price, nowadays usually in the neighborhood of 20% of the purchase price. This is done partly as a way to ensure that if the lender has to foreclose on the property, the proceeds of the foreclosure sale will be enough to pay off the mortgage loan in full. A lender/owner might do the same and require a down payment of some percentage of the purchase price.

Sometimes, the owner obtains the money to finance the loan from a third-party commercial lender. In this case, the owner may forgo collecting a down payment completely or in part and finance that part of the price for the borrower/buyer. Then the owner obtains a mortgage loan from a bank, credit union or other commercial lender and makes the down payment on the loan themselves.

Owner carry-back financing may include a balloon payment. In a mortgage loan that involves a balloon payment, the borrower makes monthly payments of only the interest on a mortgage loan for a certain period of time, such as five or ten years. At the end of the period, the borrower must pay the whole principal balance of the loan in one payment, the “balloon” payment. When the balloon payment is made, the borrower would then own the house free and clear and the mortgage loan would end. The lender/seller realizes all of the proceeds of the sale of their property. If the balloon payment is not made, however, the borrower may lose the house through foreclosure.

Variations on these arrangements are possible. So, for example, a borrower/buyer may qualify for a mortgage loan from a commercial bank or credit union, but have only a portion of the required down payment. The lender/seller may offer to finance the portion of the down payment that the borrower/buyer does not have. In exchange for the loan of part of the down payment, the lender/seller accepts a lien or deed of trust on the property which would become a lien or deed that is junior to the main lien or trust deed held by the commercial mortgage. So, the lender/seller’s mortgage is essentially a second mortgage on the property.

What If the Borrower is Unwilling to Make Payments?

Owner carry-back financing is not without its risks. Perhaps the most common problem arises when the borrower/buyer becomes unable or unwilling to keep up with monthly payments. This may happen for a variety of reasons with owner carry-back financing as with any mortgage loan.

First of all, carry-back financing is sometimes used in situations where the borrower was not able to obtain a mortgage loan from one of the usual third-party sources such as a bank or credit union. Thus, the borrower’s credit may already have been affected by previous financial setbacks, so the borrower has a poor credit rating. Arguably, then, there is an increased risk of a default on the loan payments on the part of a borrower who needs owner carry-back financing.

Owner carry-back financing might also be used where the borrower/buyer and lender/seller are acquaintances or relatives. In such a situation, the borrower/buyer may take a more relaxed approach to making mortgage loan payments, and therefore may attempt to avoid payments due to the fact that they are acquainted with the lender/seller.

However, the fact that the lender/seller is an acquaintance or relative does not relieve a borrower/buyer of their obligation to keep up with monthly payments of their mortgage loan. And it does not shield the borrower/buyer from the legal consequences of defaulting on the loan, which can include foreclosure. The lender/seller should make this clear at the beginning of the transaction.

If the borrower/buyer fails to make payments in a timely manner, the lender/seller should be entitled to take all of the actions to recover missed payments that a commercial lender may take, including foreclosure on the property. However, that will depend on the mortgage loan documents, which should spell out the respective rights and responsibilities of the parties to the loan agreement.

So, most of these disputes can be prevented through the use of a well-written contract or promissory note between the lender/seller and the borrower/buyer. The fact that a lender/seller is taking a risk of loss not taken by a seller who insists on payment in full of the purchase price of a property at the closing of the sale indicates that the lender/ seller should make sure that all documentation of the loan and the lender/seller’s security interest in the property is carefully prepared.

The contract should clearly state the provisions regarding payments, and should also state what the consequences will be in the event of a late or missed payment, as it should with every mortgage loan. One feature of an owner carry-back mortgage should be that it is secured by a lien or deed of trust on the property on which the lender/seller can foreclose in the event the borrower/buyer defaults on their mortgage loan payments.

There is a secondary market in owner carry-back mortgage loans. This means that a lender/seller can sell their owner carry-back mortgage to an investor. The sale price would probably not be the full value of the mortgage loan, but something in the neighborhood of 65 to 95 cents on the dollar.

However, this is one way for the lender/seller to minimize their risk and capitalize on the loan. The value of the owner carry-back mortgage would be greater on the secondary market, if there is a history of the borrower/buyer making loan payments on time and otherwise having the characteristics of a creditworthy borrower.

Do I Need a Lawyer for Owner Carry-back Mortgages or Lending?

Owner carry-back mortgages and financing can be a useful option in some situations. However, both lenders and borrowers should be aware of the benefits and drawbacks of carry-back mortgage loans.

If you will be entering into an owner carry-back financing arrangement, you should consult with an experienced mortgage attorney for advice. Your lawyer will be able to draft and review the loan documents, so that your interests are protected. Having a lawyer to assist you can help you foresee issues that you may not anticipate.

Consulting with an experienced mortgage lawyer has two primary benefits. It helps to ensure that the necessary documentation will work as required during the life of the mortgage, e.g. in the event the buyer/borrower defaults on payments. Additionally, it can help ensure that everyone understands how the arrangement is going to work, what performance is expected of both parties, and what the consequences of failure to perform will be.

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