Sellers offer to subsidize buyers’ financing

May 9, 2008


Tighter lending requirements and sluggish home sales have prompted many sellers to offer part of the financing needed to complete a transaction.

Q: We are shopping for our first home, and several of the advertisements we have seen state that the seller will consider "carrying back" a second mortgage. What does this mean?

A: When a seller offers to carry back part of a buyer's purchase price, it means that the seller is willing to provide some of the financing needed to close the sale. Many such sellers include "OWC" in their ads, an abbreviation for "owner will carry."

A typical carry-back involves the use of a second mortgage that requires the buyer to make two payments each month - one to the bank that finances most of the transaction, and a smaller payment made directly to the seller who holds the second.

Most sellers wouldn't consider offering a carry-back a few years ago, when it was easy for buyers to get a home loan and sales were at record levels. But carry-backs have recently become more popular, in part because lenders have tightened their credit standards and houses aren't selling as quickly.

Let's say that Buyer Baker wants to purchase Seller Smith's home for $200,000 with a 10 percent down payment of $20,000. Baker needs a $180,000 loan to complete the deal, but the bank's tougher lending requirements say he can only qualify for $155,000.

To bridge the $25,000 financing gap and make the sale, Seller Smith could agree to carry back a $25,000 second mortgage at, say, an interest rate of 8 percent for five years.

The contract could be tailored so that Buyer Baker would have to make only a $165 per month "interest only" payment to Smith, and allow Baker to pay it off without a prepayment penalty by writing a check for $25,000 anytime in the next half-decade.

Such an arrangement could benefit both Baker and Smith. Baker would be able to buy the house even though the bank wouldn't provide all the needed financing, while Smith would be able to sell his property quickly and use the net proceeds to spend however he wishes - whether it's to purchase another home, invest in a rental property or take a long jaunt around the world.

Seller Smith would also begin earning an 8 percent interest rate on the monthly payments he collects for the interest-only loan that he carried back from Baker and could also look forward to getting a $25,000 lump-sum check when Baker decides to pay it off.

Importantly, Smith also would have the comfort of knowing that the second mortgage he carried back would allow him to foreclose on Baker and possibly regain control of the property if Baker stopped making his payments.

Talk to a real estate agent for more details about the benefits and drawbacks of carry-back mortgages.

Buyers and sellers who are involved in a sale that includes a carry-back should have a real estate attorney prepare the required documents to protect their respective interests.

I bought my house with a fixed-rate, 6 percent loan about three years ago. Now, the bank that gave me the mortgage is being purchased by another bank. Can the new bank change the terms of my loan contract?

No. Federal and state laws alike require the new bank to honor the terms of the mortgage contract that you signed when you purchased the house.

About the only thing that the new bank can do is to demand that your future payments be mailed to a new address.

We signed a contract to buy a home last month and made a $2,500 "good faith" deposit. We canceled the contract a few days ago because we found an even better house at a lower price.

Although the seller of the first house has the right to keep our deposit, will we be able to deduct the "lost" $2,500 on our next tax return?

Probably not. Rules published by the Internal Revenue Service state that a home buyer cannot take a deduction for a deposit that was legally kept by the seller.

You don't dispute the fact that the seller had the right to keep the deposit, so the IRS won't give you a tax break for your sudden change of heart.

You might, however, be able to deduct your $2,500 loss if you can prove to the IRS that you were planning to purchase the house as a rental-income property instead of a personal residence. Consult an accountant for more details.


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