Should we carry the mortgage?

amysrqMay 18, 2009

Our potential buyer has a new business with a short track record. He's not sure if he can get financing yet (we're in the early negotiating stages) and has asked if we'd be interested in carrying the mortgage. We've known him for about five years and feel good about him on a personal level.

If I understand correctly, we'd have a lien on the house, which would protect us in the event of default. I also know we'd need to come up with the cash to pay off our own mortgage. He is talking about a 20% downpayment. I am thinking that we will probably pay some percentage for the cash to pay off our current mortgage and will charge him more, thereby making a margin of a few percentage points.

Of course, I'd rather not engage in this creative financing, but if it's the easiest way to sell, then I am open to the possibility. Otherwise, we get a realtor, put it on the market, wait and see and then pay commission.

Any thoughts?

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dave_donhoff

Hi Amy,

In your situation it sounds like either a Land Contract (selling on installments, rather than transferring title and carrying back a note,) OR a lease/purchase contract, might be better/safer options.

Both would allow you to leave the existing financing in place (thus not requiring you to find additional cash to pay it off in advance,) collect the 20% up front commitment money, and charge a monthly payment at a positive cashflow to your costs.

Attorneys can draw up the agreements if you already know how you wnat it structured... If you're not familiar with the ways to structure these, you need the help of someone who is.

Luck!
Dave Donhoff
Leverage Planner

    Bookmark   May 18, 2009 at 2:29PM
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mariend

I personaly would not do it unless it is a has to sell situation. The few times we got stuck financially is with someone we knew, both friend and relative. 5 years is not very long to know someone. Like Dave said, you do need a attorney specializing in these matters. And what happens if he cannot pay you and home owners insurance, flood insurance, if needed, gets sick or hurt? Or worst, gets angry and trashes the place. Or after he buys, something breaks and he thinks you should fix it, replace it etc. That is usually covered by another insurance, for at least a year. After that will he expect you to replace/fix??\
You probaly have to have the house paid for first, before you are allowed to sell it--if you move out and let him rent, you could loose your homeowners insurance. You really need some legal advice.
Just be careful

    Bookmark   May 18, 2009 at 3:23PM
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brickeyee

"And what happens if he cannot pay you and home owners insurance, flood insurance, if needed, gets sick or hurt? Or worst, gets angry and trashes the place."

You smile at the down payment you pocketed, foreclose on him, and have the property back to sell again.

Holding a first mortgage (or even a land contract/contract for deed with a wrap around mortgage) is a great way to make money.

Not much else is paying the return you can demand (slightly above market mortgage rates) with the security of a house as collateral.

    Bookmark   May 19, 2009 at 9:44AM
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Billl

"foreclose on him" - yeah, that is an easy and cost free process, right?

There is no such thing as a free lunch. You can make above average returns this way, but you do so by taking on above average risk. If you have significant cash reserves and would be able to pay all the house expenses it might take to go through a year+ of legal proceedings and resale time, then this might be an opportunity for you. If this type of transaction is going to stretch you thin and you won't have a large safety net if anything goes wrong, then you are better off finding a buyer who can get financing on his own.

    Bookmark   May 19, 2009 at 10:06AM
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brickeyee

"...a year+ of legal proceedings and resale time..."

It does not take a year to foreclose a deed of trust.
You can foreclose in as little as 60 days from the missed payment without any court action.

A regular mortgage is a harder, and can require court action.

The conditions and terms of the foreclosure are laid out in the deed of trust.

It takes banks a while since they have to direct the trustee on the deed to foreclose, then the trustee must verify everything and make sure proper notice has been given.
They hire folks for all the work.

    Bookmark   May 19, 2009 at 1:02PM
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Billl

Theoretically, you can foreclose quickly and get the house resold. In practice, there are always hangups. What happens if the person lets the house go before stopping payments? It is their property, so they are allowed to trash it as they wish. You could have a major repair bill, and major repair timeline, before the house is back on the market. Once it is on the market, it could sit there for many months. If you do not have the cash reserves to cover an extended time period with no income from that mortgage, then you aren't in a financial position to be carrying a loan for someone. If you have enough cash available to pay off a mortgage + enough income to cover insurance, heat, electricity, gas etc in the event you are back in possession of the house, plus have money on hand to conduct any unforeseen repairs, then you are in position to act as a lender.

    Bookmark   May 19, 2009 at 2:42PM
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triciae

Foreclosure times vary greatly state to state. A year is actually a pretty good average estimate. Some states have redemption time allowances. Others don't. Frequently, people losing their homes to foreclosure file BK. BK is a federal action & foreclosures are stayed for several months. A lender must request, from the Court, a Relief of Stay. That can easily chew up 3-4 months from the clock assuming the BK judge will even grant the Relief.

States using Deeds of Trust are in the minority. Some states use both.

Even with the possibility of foreclosure owner financing can be a good investment. Out of curiousity, are you aware that you can own both the house & the mortgage through your IRA account? Yes, it's a good retirement investment. Lots of rules to follow though so know what you're doing before jumping!

There's a valid reason why traditional lenders might not want to make your buyer a loan. Start-up businesses have a large failure rate. You didn't mention the type of business so I can't comment. But, your banker has a book that they use to help in assessing risk that gives those percentages. Call your banker. They'll help you & walk you through the steps should you decide to pursue.

/tricia

Here is a link that might be useful: Deeds of Trust States & Mortgage States

    Bookmark   May 19, 2009 at 2:57PM
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brickeyee

"It is their property, so they are allowed to trash it as they wish."

Never heard of the 'waste' clause?
The owner of a property that is security on a debt may not allow the property to go to wast.

It only took me about 70 days to get a defaulted borrower out of a house I held the mortgage on.

The county sheriff supervised the eviction crew after the foreclosure sale.

It does not take a year if you pursue the matter diligently, which few banks are even capable of doing.

    Bookmark   May 19, 2009 at 4:41PM
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Billl

You quoted me in your first post and then ignored half of the quote. It may not take a year to get someone out of the house, but it certainly can take a year to go through the whole process and actually get the house sold. If you haven't noticed, most markets are pretty slow right now....

Also, the "waste" clause is pretty useless if the person has no money and assets. Trashing a house has become and all to common occurrence in foreclosures recently. You can try to collect money from them after the fact, but if they are defaulting on their mortgage, it is pretty likely that they have no assets to go after. If the purchaser is self employed, any damages would be VERY hard to recover.

The OP stated that the potential purchaser had a relatively new business and might not qualify for a conventional loan. There is a reason that many banks won't get involved. This is an incredibly risky loan and has a good chance of defaulting. If the OP isn't financially prepared to handle the consequences of the risk, then they shouldn't take the risk.

    Bookmark   May 19, 2009 at 4:54PM
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triciae

brickeyee,

In some states is does take a year even if everything goes smoothly. Just because it doesn't in your state doesn't warrant your blanket statement of, "It does not take a year if you pursue the matter diligently, which few banks are even capable of doing."

It matters not one bit how "diligent" you are if there's a year redemption period. You can't prevent a borrower from filing BK & you also can't get the Stay lifted without the BK judge's authorization.

Here's a link to some brief & quick state foreclosure stats. This should not be taken as complete but does show the variance state-by-state.

/tricia

Here is a link that might be useful: Foreclosure Stats (State-by-state)

    Bookmark   May 19, 2009 at 5:01PM
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amysrq

Wow! Lots to digest here. We have a house guest, so I only have half an eye until tomorrow night.

In answer to this:

If you have enough cash available to pay off a mortgage + enough income to cover insurance, heat, electricity, gas etc in the event you are back in possession of the house, plus have money on hand to conduct any unforeseen repairs, then you are in position to act as a lender.

Yes, we are in a position to deal with this.

Though I know people don't always turn out to be what we think they are, this guy is one of the most fastidious people I know. Not that that has any actuarial value. His business is an independent off-shoot of what he's been doing for years...providing services to the legal industry. That doesn't mean anything either, but he's not starting a restaurant or out busking.

Tricia, I assume the stats you linked to are good for me if they are low. I am in MA.

Dave, Marie, Brick, Bill and Tricia...thank you all for weighing in. I'll be back after my company gets back on the train. :-)

    Bookmark   May 19, 2009 at 5:57PM
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brickeyee

If you look through the site tricia posted you can tell that only a few state have a redemption period of a year (13 of 50).

The duration has been exaggerated.

New York has the longest process period at 445 days (yet another reason to stay away from attorney central).

If you push hard things tend to move through the system faster, if only because the participants get tired of repeated call and questions and inquiries.

The squeaky wheel gets the grease.

While many places do not use ;deed of trust; they are so backwards it is almost funny.
All straight mortgages do is slow the process when miscreants default on a mortgage.

The deed of trust method eliminate a lot of legal BS and court involvement by defining how the default will be handled (the trustee already had all the legal powers needed to complete the foreclosure).

Of course all the attorneys in the mortgage states will loose work, so do not expect change to occur.

I had a Virginia property that an employer wrote a mortgage deed on for a bridge loan. My attorney told me that if I terminated my employment early it would cost them more to try and foreclose than the amount of the debt.

Corporate attorneys are NOT real estate attorneys (though their salaries would indicate they now all).

    Bookmark   May 19, 2009 at 8:17PM
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triciae

You're lack of breadth of knowledge, experience, & credibility is showing, brickeyee. :)

/t

    Bookmark   May 20, 2009 at 6:19AM
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brickeyee

I have only been buying, selling, and renovating houses for 30 years in multiple states with all sorts of varying deed and mortgage rules.

I have purchased foreclosures as far back as 25 years ago, when most banks gave a blank look when they realized they needed to now sell the property.

Some had essentially no process and did it sort of ad-hoc.
A few had poor lending practices and had a little more experience.

I have never liked the mortgage states, and neither have any of the attorneys I have used when dealing in them.

Every one (about a half dozen) thought the Deed of Trust system was superior, especially when it came to actually handling a default.

    Bookmark   May 20, 2009 at 10:32AM
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triciae

Well, brickeyee, whether you like or dislike mortgages is not much use to the OP, is it? They are in Massachusetts...a mortgage state.

So, carry on your commentary about your preference for Deeds of Trust; but I seriously doubt a MA court will be much impressed. :)

I was still a kid 30 years ago; but I count the number of foreclosures I've conducted in the thousands. And every single one of them I've ultimately sold to an end user.

For the OP...

Before you make a decision...ask your banker to look up the purchaser's business in his/her RMA. The RMA is the industry standard for business risk management. RMA used to be Robert Morris Associates but they changed their name to the Risk Management Association a few years back. That, combined with D&B risk management should help you determine the long-term viability of the business.

/tricia

    Bookmark   May 20, 2009 at 12:35PM
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amysrq

Well, our friend does not want to buy the place after all....personal issues, wrong timing. Too bad.

Now we are off to explore FSBO.

Thanks everyone for the thoughtful advice.

    Bookmark   May 29, 2009 at 8:38PM
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