Seller carryback financing is when the seller of a given property acts as a lender for a buyer on the seller’s property. The end result is that the buyer signs a promissory note to the seller, for the amount of the carryback with a set interest rate, set monthly payments, and a set time for when the loan is to be paid off. The promissory note is typically secured by a trust deed recorded on the seller’s home, preferably in a first secured position, but frequently in a junior position to some other lender’s secured loan on the seller’s property.
A seller carryback is a means of getting a parcel sold particularly if a conventional bank will not offer the full amount that the buyer needs to close the sale.
Even though a properly-drafted seller carryback will provide a monthly income stream for the seller of a given property, the seller carryback does have inherent risks that a real estate licensee needs to advise his or her seller of in writing before close of escrow.
Risks of a Seller Carryback Loan for the Seller
As in any sale and purchase of real property, there are inherent risks of potential litigation. None are more so in a seller carryback loan. The risks to the seller are exacerbated if the seller is not in a first secured position on the carryback. In this case, the seller, in order to protect his or her junior secured position, most likely will have to keep current all defaulted senior secured loans or face the possibility of being wiped out in a foreclosure proceeding. If the property forecloses, the seller will have no recourse against the new buyer for the carryback loan fulfillment as a matter of law, and will lose what is owed under the seller carryback.
The greatest concern in the seller carryback loan is a default by the borrower buyer. Should a buyer in a seller carryback transaction default on the loan, the seller is forced to foreclose on the security if the buyer will not voluntarily cure the default. If the seller forecloses on the security and ends up with legal title to the secured property, evicting the buyer post foreclosure can be both expensive and time consuming.
Another potential seller carryback risk is if the buyer-owner makes alterations to the sold property after the purchase is final, and foreclosure happens prior to the repairs being completed. If the seller with the carryback loan takes back legal title, he will have repairs to complete that were not anticipated when the trust deed securing the buyer’s promissory note to the seller was recorded. Repair costs could be in the tens of thousands of dollars, and may need to be completed prior to attempting to resell the property, to recover the value of the seller carryback in addition to the payoff value of a potential first secured position loan.
There is also a significant seller carryback risk is when the loan payoff in full is due. The buyer may make nondisclosure claims against the seller for the first time as a means to renegotiate the terms of the secured promissory note. These claims can center around undisclosed water intrusion issues, undisclosed foundation issues, and similar issues, where the buyer contends that such information was known by the seller well before close, and was material to the price and desirability of the property.
Risks of a Seller Carryback to the Listing Agent
Seller carryback loans are a big risk particularly for the listing agent. There have been situations where the seller is in a second secured position on a $100,000 or more carryback, and the seller cannot keep the first secured lender on the parcel current when the buyer-owner defaults. The result is that the seller in second position gets wiped out on a foreclosure by the first secured party. The seller then looks to get reimbursed because his or her real estate agent did not advise him or her in writing about the inherent risks of a seller carryback, particularly in a junior position. As a result, the listing agent gets sued for negligence or, worse, for breach of a fiduciary duty due to failing to properly advise on a seller carryback. Damages would be loss of the principal amount of the carryback, prejudgment interest, and assorted costs incurred in protecting the security under the second trust deed.
How to Protect the Seller and Yourself in a Seller Carryback Transaction (details are for California)
In the event that your seller is considering a seller carryback as a means of selling the listed property, check with your broker or state’s real estate commission to obtain a “Seller Financing Addendum and Disclosure” or similar disclosure form to provide to the seller client for a detailed review and discussion. Should the seller want to do a seller carryback, the seller and the buyer need to date, sign and initial the disclosure form well before escrow is closed. Save this dated, initialed and signed form in your file. If you’re licensed in California, read our CA real estate attorney’s guidance at the end of this article.
It is recommend that the agent send an email to escrow, suggesting that the trust deed being drafted by title have provisions within that:*
- The buyer is to keep all property tax payments current
- The buyer must have written permission from all secured lien holders (senior/first and junior position lenders) before any alterations to the sold property exceeding one thousand dollars ($1,000.00) are made.
However, check with your state regulations to ensure you follow any state specific guidelines for seller carryback transactions.
The last thing the secured parties want is to foreclose on a home that has unfinished and perhaps unpermitted construction. Forward the email to the seller client suggesting that he/she consult with an attorney and a tax professional before fully committing to any seller carryback loan.
As with any transaction that causes you to pause and have doubt, contact ClaimPrevent® Legal Advisory Services (included with your CRES E&O policy). They can help you determine if all aspects of a seller carryback transaction have been addressed to help you reduce your risk of a real estate lawsuit.
California Licensees: How to Protect the Seller and Yourself in a Seller Carryback Situation
In the event that your seller is considering a seller carryback as a means of selling the listed property, in California, you should present the C.A.R. form SFA entitled “Seller Financing Addendum and Disclosure” to the seller client for a detailed review and discussion. Should the seller want to do a seller carryback, the seller and the buyer need to date, sign and initial this form well before escrow is closed. Save this dated, initialed and signed form in your file.
Contributing author: Real estate attorney Edward McCutchan of Sunderland-McCutchan, LLP.
Have you had a seller consider a seller carryback loan — how did you advise them of their options?