Seller’s Risks with Owner Financing
1. The buyers may not pay. This is the only risk novice buyers
and sellers really think about. Participants in a owner financed
transaction need to realize they are going into the banking business
in a small way. Everyone knows banks have large buildings
and make a lot of money. They sort of forget banks also take some
heavy losses. However, banks get to play the odds. They
try to make more loans on which they profit than loans on which they
take a loss. For the seller trying to unload his house the news
on the day the monthly payment is due is either all good or all bad. Sellers
frequently insist on terms that actually increase the chances the loan
will get into trouble.
2. The sellers may need their cash faster than the contract pays. This
can be a subtle trap.The sale is done and some time later something happens
in the sellers life which causes them to need a chunk of cash. The obvious source of funds would seem to be selling the contract for cash. After all, the buyer has been paying every month and the interest rate on the
note is well over what banks are paying on CD’s.
A few calls to the note brokers advertising in the paper will spoil
that illusion. In the United States home ownership is reguarded
as a sacred right and governmental systems are in place to make sure
cheap money for home buyers is always available. The government
backs the bonds that get issued to provide the money so loans can be
made at the lowest possible rates. When you try to sell a privately
held note the buyers of the note will expect much higher rates. The
way they do this is to discount the value of the note.
Note discount calculations are complicated and depend on a lot of factors. However,
even a short term note, with market interest rate, and a good payment
history may be discounted by 25% or more. One of the difficult
parts of being a note broker is educating consumers about the true value
of their note on the open market. Successful note brokers typically
do that by proposing terms which help the note seller feel like they
are getting more for their note than they really are. This works
because few people really understand the mathematics of notes.
3. There may be unintended tax consequences. As
long as the seller continues to hold the note and reports the interest
as income the tax situation remains simple. For the buyer the interest
is deductible and the tax results are obvious. The tax situation
is more complex if the note gets sold to a third party at a discount. It
will also be more complicated if seller financing was used in the sale
of an income property. In that case the sellers “basis” in
the property comes into play and the allocation of the money from the
payments is more complex.
4. There may be title/ownership issues. Title
issues are rare in the residential home market. Subdivisions have
to on the books for years so there are few boundary issues. Title
insurance is a almost always used so potential problems are found and
corrected early. With land and income property title related problems are more likely. Owners
get sued, make bad business decisions, fail to pay their taxes, get divorced
and do other things that result in clouds on the title. Even with
residential property, sellers may “forget” to mention they
deeded an interest in their home to their kids who then will have to
sign the deed as part of the sale. Even though it is expensive,
I would strongly suggest title insurance.
5. Poorly drawn paperwork puts sellers at risk
of not being able to enforce the contract. Serious problems
will require a trip to court to resolve. THis is expensive and
takes a long time. In the
meantime the buyer may live the the property for months without making
payments. The seller is stuck making payments on the underlying
loan(s) to protect his equity without any income. I have known
sellers who would drive buy “their” property and watch it being
destroyed without being able to do anything about it. In court
the only thing which will really matter is the paperwork. Things
that were said or promised are not considered. This is the time
when the seller may realize the generic document they got at the stationary
store really doesn’t protect their interests well. In other words,
the parties to a seller financed sale should do everything with the idea
that they may eventually be in court and the documents they are signing
will determine what happens.
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what happens to me (seller) if the buyer claims bankruptsy?
Assuming your papers were drafted properly and recorded you will be a secured creditor. As I recall, the buyer should have the choice of “Re-affirming” the loan, meaning they promise to continue paying. If they do that and fail to make payments you foreclose as usual. If they choose not to, you get your property back and can sell it to someone else.
The problem of course it that this may take a while, a house may be getting damaged during the process, etc.
What is involved in foreclosing. I am selling some land and owner-financing and of course am worried that the buyers will default on their payments. Is this expensive or do I just need a real estate lawyer to write up the foreclosure papers.
Foreclosure is a process and the procedural requirements for notice, etc. are defined by law. How the foreclosure is actually done is also controlled by the note and mortgage used for the sale. In other words, you need to have a knowledgeable real estate attorney draft your sales documents. Then if you get into a foreclosure situation you will know that you are as well prepared as possible from a legal standpoint.
Reading from the above reply regarding foreclosure, I am in this situation. I have not received a payment since April 2010 on my mobile home/land lot. My note was created by the title/real estate company. I contacted the title company regarding foreclosure and they asked for $2k to get it started, my problem is that the entire mobile and lot are valued at $13k (I originally paid 65k cash and then sold it for 50k) with such a loss already I was hoping to do the foreclosure paperwork myself. Do you recommend this?
No. You need local expert help. The rules and requirements for foreclosure are different in different states. There are also local variations in how things are done. In some parts of the country title companies are important. In others lawyers do the title work. You need someone who has experience doing these. Do you have any local people you can call for recommendations? By that I mean experienced real estate investors, rental property managers, NOT their son, nephew, etc. You need to be represented by someone who is actually in court on foreclosure/evictions several times a week.
You may also want to talk with a tax person to see if there are ways to net your losses against some gains to reduce the pain of this whole experience.
Good luck.
My husband and I bought a business property, seller financed, due to City and RR shut down the only alley with access to our parking lot, we were forced to relocate the business. The seller claimed to have a financial interest in the property and met with city officials, without our knowledge or permission to determine if the city’s action would cause harm to the property. We defaulted on the mortgage 4 months after relocating. Seller foreclosed and after auction at the courthouse steps, seller “bought” property themselves for 1 year back taxes owed. They own the property, now they seeking $80K from us, claiming they paid themselves $75K for the property and we must pay the shortfall of the sale. Can an owner finance seller retain ownership of the property and also claim additional funds from buyer? or would this be a form of fraud?
I can make suggestions about creative ways to improve deals before they are done. I can suggest things to be concerned about before your attorney drafts the actual documents. In this case, where there is a series of events that have already happened I can’t offer anything. You need to contact an experienced local attorney and decide what the best outcome of this problem would be and how you can get to that point. A favorable solution will depend on a combination of what is legal and what can be negotiated. Good luck
I am selling my home and acreage under owner finance. I don’t owe anything on this property. My buyers have not made a payment in 3 months and a payment on premium as agreed in contract. I need to I have given buyer (not in Writing, but text) notice he has until end of Aug. to get caught up or I will recall the loan, as stated in the contract that I have the right. I need advice on this predicament. He has been late every month since purchase and had 2 insufficient funds costing me a service charge for rerun of checks, now I require payment to be made in cashiers checks. I want to recall this loan. Please advise. Thank You
You are being to nice. In real estate it doesn’t count unless it is in writing. Getting your property back will require you to carefully follow all the “Due Process” set out by the statutes in your area. There are rules about how notice must be given, making sure you have proof of service, how much time the other party has to respond, etc. It’s time to “Lawyer up”. Find an attorney with an active foreclosure practice, not a friends nephew or someone you just happen to know about. This is NOT something you should attempt yourself no matter what your contract says.
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