Believe it or not, getting a mortgage from a bank is not the only way to finance the purchase of a home. In fact, seller-financing in real estate and, in particular, seller carry-back mortgages can often be a viable alternative to a traditional mortgage loan.
If you’re wondering what a seller carry-back mortgage is, read on below. This is your guide to the carry-back mortgage process.
What are seller carry-back mortgages?
In real estate, seller carry-back mortgages fall under the umbrella of owner financing. Owner financing, or seller financing, occurs when in lieu of getting a mortgage from a bank or lender to purchase the property, the buyer contracts directly with the seller to buy a home. Once the sale goes through, the buyer is then responsible for making regular installment payments to the seller in exchange for equity in the property.
Though the term can sometimes be used to refer to a property that’s completely financed by the seller, with a carry-back mortgage loan, typically the seller agrees to finance just a portion of the home’s purchase price.
In this case, while the bulk of the money may come from a traditional bank loan, the seller might agree to finance an additional percentage of the purchase price, giving the buyer the opportunity to make a smaller down payment.
Once the seller financing terms are agreed upon, they are typically secured by creating a mortgage and a mortgage note. Though, these agreements can also be documented with a land contract or deed of trust. However, once the documents have been recorded, the carry back mortgage becomes a second loan on the property.
How it all works: A seller carry-back mortgage example
Let’s say the buyer agrees to purchase the home for $100,000. However, they are only able to get bank financing for up to $80,000 and they only have $10,000 saved up for a down payment. In this situation, rather than allowing the sale to fall through, the two parties may be able to reach an agreement to seller finance a home loan worth the final $10,000.
Reasons to consider a carry-back mortgage
Traditionally, seller carry-back mortgages are mostly seen in down real estate markets. After all, owner financing allows buyers who may not be approved for bank financing the chance to become a homeowner.
In the right circumstances, it can be a win-win situation. The buyer gets the financing they need to buy a home and the seller is able to sell their home, often at a better rate of return than they would get with a different investment of a similar size.
Put simply, properties that are owner-financed usually garner a higher sale price. For their part, buyers may be willing to pay more if it means they have a viable route to becoming a homeowner. On the seller’s end, they can get more money out of the sale of their investment, plus they can often charge interest to compensate them for the hassle of having to act like a bank.
Potential disadvantages of a carry-back mortgage
The biggest disadvantage of agreeing to carry-back a mortgage is that you are taking a risk. There is a risk that the buyer may stop making regular payments on the home, at which point you would be responsible for initiating foreclosure proceedings.
Additionally, even though you’ve sold your home, if you’re accepting monthly payments, it will take you a long time to recoup your investment.
While it may be nice to have an added source of monthly income, you won’t be able to take the money from the sale of your home and leverage it to buy something else in the same way that you would if you sold to a buyer who had used bank financing.
Selling your carry-back mortgage
Luckily, there is a happy medium where you can offer seller financing in order to find a buyer for your home and still receive a lump-sum payment. You can sell a mortgage note that you carried back to an investor like Amerinote Xchange.
Keep in mind that investors need to see a benefit from buying a mortgage note, which means that they will likely buy it at a discounted price. That said, there are several factors that go into determining how a mortgage note is priced.
Factors that influence the mortgage note sale price
Seasoning: The term “seasoning” refers to the buyer’s payment history. A seller who has received timely payments for a year or more will get a better bid than one who doesn’t have the same proven track record.
Loan-to-value ratio: Since higher loan-to-value ratios represent a greater risk to the investor, sellers with these notes often face steeper discounts.
Interest rate: On the other hand, higher interest rates mean more profit for the investor, so the higher your interest rate is, the lower your discount will be.
Amortization: Shorter amortization mortgage terms signify that an investment will pay off sooner. With that in mind, investors will usually pay more money for loans with shorter terms.
Recourse: Finally, a mortgage note that includes a payor that is an individual person instead of a corporation like a limited liability corporation will price the loan more favorably.
Lastly, in a mortgage note sale, there are a few fees that will be incurred. Typically, investors will ask sellers to shoulder these costs, so it’s best to be prepared for that going in. To give you an idea of what to expect, the fees you’ll see are similar to the closing costs when you sell a home. They are as follows:
1. Title search and insurance
2. Document preparation
3. Escrow fees
4. Appraisal fees
5. Wire transfer fees
6. Creation of a beneficiary statement
7. Recording the deed
8. Commission fees
What happens to a mortgage note after it’s sold
Typically, after buying a mortgage note, investors will either hold the loan through maturity or sell all or a portion of the loan to another investor or entity. This is considered whole loan trading, not to be confused with a mortgage-backed security.