Trying to Understand Seller's Financing (for a house)

[wilkens21]

Hey folks, I've done a little bit of reading on it from various websites, but would to know if folks have experience with this. Basically I'm thinking about selling a house in this bad market, but most buyers are not able to put the 20% down to make the down payment outright and then are subject to the dreaded PMI.

However, the PMI insurance companies have been rejecting people left and right because they are scared off with our nation's credit mess. Since there are only a couple of PMI firms that all the major lenders use, if someone is rejected by one company, they're rejected basically all of them if they cannot secure a regular 20% down loan (even if they re-applied).

But I'm wondering about doing this:

1. Potential buyer puts say 15% down
2. I cover the other 5% via seller financing
3. The bank puts up the other 80% and hence the mortgage that the buyer has to pay for the next X-amount years of his life

What can I do (legally) to protect myself from point #2 if the buyer defaults? I know I can charge interest and basically act as the PMI insurance and get a decent return back on my money as long as the buyer can still afford to make the payments (it would be have to be a short term loan).

What about the original property itself, could I legally have a right to a "portion" of the property if the buyer defaults? Or does the bank now technically "own" it outright and then can foreclose on it and leave me out in the dust (even if the buyer still owes me money on the loan)?

Have lots to learn and thanks for reading this.

- wilkens21

 

[clifp]

The typical way that seller finance works is you put a 2nd mortgage on the house. Of course banks are fairly smart about this and if they see a 2nd mortgage than they can refuse to fund or even possibly call the 1st mortgage. So you need to work with somebody who has experience doing this some RE brokers, or perhaps a lawyer.

Your legal rights as 2nd mortgage are the basically the same as any mortgage holder. If you stop getting payments you can foreclose. However and this is important the way a 2nd mortgage works, is that holder of the 1st mortgage (i.e. the bank) gets every dollar owed to them before you get a penny.

In a fairly typical situation (when something goes wrong) the 1st mortgage holder will initiate a foreclosure, sell the house at auction. Recover all the money owed to them (including expense and late penalties) than any additional moneys go to you the 2nd mortgage holder, and than if money is left over to the buyer. Of course lately banks lose 10-30% on foreclosures so 2nd mortgage holders get zipo, nothing, nada.

 

[wilkens21]

clifp: this is good information and i appreciate the insight. if i were to pursue this, it would be in my best interest to let the 1st mortgage lender know early correct in order to make the chances of this succeeding (ie: they don't deny the mortgage outright to the buyer)?

i suppose they (1st mortgage lender) would need to know since they are looking heavily at the potential buyer's stats/credit history and would see a shortfall and the need for this secondary loan.

i understand some of the risks involved (still learning about this process), but from what i've read if it does go through, an ideal time to do this is when interest rates are low (which they are now), and this might be a way of making some extra money (on the interest), which would definitely pay more than any CD out there.

 

[Martha]

You also generally have the right to cure defaults on the first mortgage and if the mortgage lender forecloses, the right to pay the first mortgage off and foreclose your own mortgage.

But these take a lot of money that most second mortgage holders are not going to want to spend unless there is substantial equity in the property. Most second mortgage holders get foreclosed out and get nothing out of the property.

 

[clifp]

clifp: this is good information and i appreciate the insight. if i were to pursue this, it would be in my best interest to let the 1st mortgage lender know early correct in order to make the chances of this succeeding (ie: they don't deny the mortgage outright to the buyer)?

i suppose they (1st mortgage lender) would need to know since they are looking heavily at the potential buyer's stats/credit history and would see a shortfall and the need for this secondary loan.

The honest answer is I don't know. At various times several members of my family were involved with seller financing, in the mid 70s and than in early 90s. Roughly 20-30% of notes had some type of problem. (I think this is on the high side). A board regular calmoki (sp)has done a quite a bit of private mortgage lending, he maybe able to give you some solid advice.

If you are in financial position to take over the first mortgage and you are confident that housing prices in your neighborhood aren't going to drop by more than 20%, than I'd say it is probably an acceptable risk. If it is a choice between selling the house and losing the sale than there is an added incentive. However, as way easy way of making more than a CD, I would be cautious. You can easily get 5-10 year corporate bonds from household name companies like International Paper, Xerox, American Express that pay 7 or 8% which is probably comparable to the rate you'd get on 2nd mortgage. Ask yourself who is likely to pay you back?

 

[calmloki]

One way to look at it is this: you get the house sold and pocket 95% of your selling price (15% from the buyer and 80% from the lender). You carry a second for 5% of your selling price. You have the chance to make some interest, and hopefully the buyer (risking 3 times the money you are) manages to pay as agreed until he sells, at which time you get cashed out (do use non-assumable language in your loan). If the buyer defaults you may not want to dummy up the amount of the first mortgage plus their fees & legal costs to buy your house back - but you sold for 95% of your negotiated price + whatever the buyer managed to pay you. It probably isn't cost effective for the buyer to go belly-up right off the bat, so you should get some of the 5% at any rate. Might be worth the risk to make the sale....

Can't believe times have come to the point we have to consider the risk of losing 5% on a property sale - or that losing 5% might be worthwhile! Don't house prices always go up?!

 

[W2R]

I wouldn't carry a second mortgage for a buyer.

I saw another option on HGTV that could at least ease things for a cash-strapped buyer. That is for the seller to cover the closing costs. Then the buyer can take the money he had planned to use on closing costs, and apply it to the down payment.

 

[Martha]

I wouldn't carry a second mortgage for a buyer.

I saw another option on HGTV that could at least ease things for a cash-strapped buyer. That is for the seller to cover the closing costs. Then the buyer can take the money he had planned to use on closing costs, and apply it to the down payment.

The problem with this strategy in a down market is that the buyer is banking on the property appraising for the selling price, which in a sense is artificially high as the seller is taking less because the seller is covering the closing costs. We had a potential buyer for our place. The buyer offered a high amount but we would have to cover closing costs, essentially a deduction from that price, plus the offer included an amount for the buyer to purchase most of our furniture. I questioned whether the place would appraise high enough to justify all that the buyer wanted to finance. Never got that far though because the buyer could not meet other contingencies.

 

[BUM]

Hi wilkens21, Why not jump right in as 1st mortgage holder? I assume we're talking about a house you own. Get what down payment you can, and charge reasonable interest. The buyer gets cheap closing costs, no pmi. You get monthly income and if it all turns brown (it probably won't) - foreclose. Lots of ways to make this work.

This is not a unique approach, might even be a trend. People (relatives) moving in, or back in together, sharing ownership.

Poppy's holding the mortgage.