What Are the Risks of a Seller Carrying a Home Loan?

Sellers assume risk of default when they carry a buyer's mortgage.

Sellers rarely become involved in their buyers' mortgages. However, sometimes major lenders are not willing to give buyers enough money for the property, or the seller has the ability to lend money directly to the buyer to shorten the process. This is known as carrying a home or a seller carry-back. This means that the seller, now also the lender, can dictate many of the terms of the loan, and the buyer does not have to worry about getting funds from somewhere else. However, there are also certain inherent risks in sellers carrying the loans used to buy their own properties.

Default

For the seller, the biggest risk is that the borrower will default on the loan and be unable to pay it off. The seller may have the property as collateral, but he is now back at the beginning of the process, minus all the time and expense of issuing a useless loan. This may be even more true of borrowers who must use a seller-carried loan to buy the property, since this usually means that the buyer has been rejected or only offered smaller loans by major lenders because of the risks involved.

Interest Rates

In a seller-carried mortgage, the seller gets to decide the interest rate and interest rate schedule. Financial organizations like Fannie Mae do impose some limitations on this process, and the seller cannot simply offer a zero interest rate (which may occur between family members), but most of the decisions are still up to the seller. This adds a significant risk if the seller is inexperienced or does not read the market correctly. If they choose a low rate that the market does not support, the borrower will be unable to easily refinance, and the seller may not make enough profit to justify the process. A too-high rate can make the borrower angry and increase chances of default.

Lease Transfer

A lease transfer is a type of seller-carried home loan in which the seller retains the deed to the property, in effect leasing it to the buyer while the buyer makes payments. The buyer must pay off most or all of the loan before the deed is transferred to her name, making her the owner. This creates a risk for the buyer: if the buyer misses a payment or somehow breaks the mortgage contract with the seller, the seller can retain the title and the buyer's payments will not have counted for ownership.

References

• NOLO: Seller Financing: How It Works in Home Sales
• OCRegister: Is seller financing worth risk in home sale?