With the purchase-money mortgage, the seller doesn't actually give any money to the buyer, as would a conventional lender. He simply extends credit, as it were, to the buyer against the purchase price of his property. The buyer signs a promissory note and trust deed agreeing to pay the seller a certain amount each month to be applied against the principal, plus an agreed upon interest amount at a specified rate on the unpaid balance. Should the buyer default, all avenues of foreclosure given a traditional lender are open to the seller.
The agreement contract, promissory note, trust deed, and all legal documents should ultimately be prepared by a competent attorney for the protection of both buyer and seller; and the transaction properly recorded giving public notice of the title transfer and mortgage.
Seller financing can bring a higher price, and help a buyer, who under ordinary circumstances, may not be able to complete the transaction. However, it is critical for the seller to thoroughly evaluate the credit-worthiness of the buyer.
Is the borrower a good credit risk?
You should run a full credit check on the borrower, require hazard insurance on the property and include a due-on-sale clause. There also are financing, disclosure and repayment-term requirements that need to be met. It is wise to consult a lawyer when putting together this kind of transaction.
Suppose Mr. Sellers currently has a $70,000 mortgage on his home. Mr. Byers makes an offer to purchase the home for $100,000. Mr. Byers says he can pay $5,000 down if Mr. Sellers will finance the remaining $95,000..
Mr. Sellers sees an opportunity to make some money. The interest rate on his current loan is only 5.5%. The going current market interest rate is 7.5%. He then offers to carry Mr. Byers' $95,000 mortgage for 8%.
Because Mr. Byers' credit history isn't what it should be, he jumps at the chance to avoid the hassle of getting a conventional loan. To protect both of them, they execute a legal "deed of trust" and properly record it. (Note: this is the second deed of trust recorded for this property! )
Mr. Byers' $95,000 mortgage "wraps around" Mr. Sellers' $70,000 mortgage. Mr. Byers moves into the house, and makes his 8% interest and principal payment monthly to Mr. Sellers on his new $95,000 mortgage. Mr. Sellers continues to make his 5.5% monthly interest and principal payment to the original lender on the $70,000 mortgage and pockets the difference as profit.
Everybody's happy? Maybe.
Although the agreement between Mr. Sellers and Mr. Byer is perfectly legal, it is not without risk. This arrangement works as long as Mr. Sellers' original loan agreement does not contain a "due-on-sale" clause, and it is highly likely it does. Should there be a 'due-on-sale' or a 'due-on-transfer' provision, the remaining balance of the underlying loan might be 'called due' and 'payable' when the original lender becomes aware that the property has been 'sold' and title has transferred. The original lender might then invoke their first "deed of trust" and sell the property for the amount of principal that has not yet been repaid. Mr. Sellers could lose his $95,000 mortgage and Mr. Byers could lose the house.
Mr. Sellers would argue that the original lender would never, especially in this age of the foreclosure, go through the time and expense to invoke the "due-on-sale" clause if his payments were timely made. Maybe so, but, never, never enter into it without the help of a competent title attorney to advise you of the inherent risks and to write a contract that protects both your interests, as well as the seller's.
The "wrap-around loan" can be a useful tool to both buyer and seller if it's applied correctly and under the right circumstances.
You should first find out what rates conventional lenders are currently charging. Freddie Mac's Primary Mortgage Market Survey® is one place to search. You can also ask your RE/MAX Valley agent to check with several local lenders or mortgage brokers. Although, you may end up paying a slightly higher interest rate, seller financing will usually be far less costly than conventional financing because sellers won't charge points, loan origination and processing fees.