If you are selling your home and have considered financing the purchase for a potential buyer (sometimes called a seller carryback), then you should also consider the worst-case scenario: What happens if your buyer fails to make payments in a timely manner or stops making loan payments altogether?
When working with your lawyer to draw up the loan papers, make sure that the document discusses how late payments will be handled. Among the questions to consider:
- Will late fees be charged?
- How much of a late fee will you charge?
- Does the buyer have a grace period before the late fee is assessed?
- Does the interest rate change if the buyer's payments are past due?
- Is there a separate fee if a balloon payment is late?
If the buyer is unable to make his monthly loan payments, then the lender (or lenders) can foreclose on the home. In foreclosure, you regain possession of the home and the buyer is evicted from the property. The home can then be resold in an effort to pay off the outstanding balance on the loan.
Foreclosure laws vary from state-to-state, and you may only initiate foreclosure proceedings after a certain amount of time has passed. In addition, in the loan documents you should consider addressing your right, as the lender, to foreclose on the house. This may enable you to sell the property, if certain conditions are met, without a court order.
Primary or Secondary Financing?
Before deciding whether to offer carryback financing, it's important to understand whether you are offering the primary financing or secondary financing.
If a traditional lender, such as a bank, is also lending the buyer some money to purchase your home, then that lender is usually considered to be the primary lender. If the buyer defaults on his loan and the house is foreclosed on, then proceeds of the sale would first be used to pay the money owed to the primary lender, then any money that's left over would be used to pay the secondary lender. (If there are more than two lenders, remaining money would then pay off the balance of those loans.)
As a seller who is offering financing, it is in your best interests to be the primary lender because you stand the best chance of recouping your money if the buyer defaults on his loan. The danger of being a secondary lender is that after the debt to the primary lender is repaid, there may not be enough money left to pay any or all of what's owed to you.
Questions for Your Attorney
If you are offering seller financing, it is worthwhile to hire a real estate attorney who has prior experience with these types of transactions. Your lawyer can draw up the loan documents and ensure that you have built in safeguards to help protect you in the event that the buyer misses payments or defaults on the loan.
Among the questions to consider asking your attorney:
- Have you previously represented clients who were offering carryback financing?
- Do you have experience writing a financing contract?
- How much do you charge for your services?
- Will the buyers pay most or all of your fees?
- If we have to foreclose, will you represent us in the foreclosure process, too?
- What is the cost to us if we have to foreclose?
- What are the foreclosure laws in this state that are relevant to seller financing?