Seller Carryback Financing: How It Works

Struggling to qualify for a conventional loan and running out of options? Luckily, you can use a creative financing strategy for investment property — seller carrybacks.

As a real estate investor, I love using seller carrybacks– it’s a flexible arrangement I regularly use to acquire properties. In fact, we used seller financing on the first properties my husband and I bought during the 2000s!

In this article, I’ll teach you how you, too, can use a seller carryback loan in your future deals by discussing its definition, uses, and applications, as well as assess if this loan is for you from both a seller and buyer perspective.

TL;DR:

• Seller carryback is an option when the buyer doesn’t qualify for a conventional loan or has insufficient down payment.
• The property owner/seller acts as the bank for the property buyer and provides financing.
• Both parties negotiate the purchase price, down payment, market-based interest rate, and repayment schedule.
• Seller carryback may need a real estate attorney to write a formal document to protect the interest of both the buyer and the seller.

What is Seller Carryback?

Also known as owner financing or purchase money mortgages, seller carryback is a flexible financing option where the property seller acts as a “bank” and “carries back” a portion of the purchase price by providing financing to the buyer.

This arrangement allows the buyer to conveniently purchase the property when conventional lenders close their doors on them. Additionally, you can use seller carryback for residential and commercial deals.

Why Use Seller Carryback?

Seller carrybacks are becoming increasingly popular today as getting traditional home loans from banks becomes more and more challenging.

First, seller carryback can make your property more appealing to a wider range of buyers– specifically, those who are limited by their poor credit score, unstable employment history, or have a high Debt-To-Income (DTI) ratio.

Next, seller carryback can lead to a faster sale since there’s no need to go through traditional bank lenders, which can be an advantage since some buyers are willing to pay a premium price for the convenience and flexibility it offers.

How to Do Seller Carryback

Seller carryback consists of a step-by-step process for both parties. Here’s a general outline that typically plays out in a carryback loan:

1. First, the seller researches the prospective buyer’s financial status.

While seller carryback financing can be a flexible and attractive option for both buyers and sellers, it also involves some risk for the seller.

That’s why it’s practical to research the buyer’s financial status or history when you’re considering seller carryback financing as a seller. They may request to pull up a potential buyer’s credit report, pay stubs, tax returns, bank statements, and investment accounts like a traditional bank before negotiating terms with them.

1. The buyer and seller negotiate terms.

The buyer and seller negotiate the terms of the sale of the seller’s property which is compiled and documented in a purchase agreement. They include, but are not limited to the following:

• sales price
• down payment
• market-based interest rate
• repayment schedule

1. The buyer and the seller sign a promissory note or a trust deed.

Once both parties come to terms, the buyer either signs a “promissory note”, a legal document that contains the agreed loan amount, down payment, interest rates, and repayment schedule.

Additionally, the seller may bring in a third-party entity to create a trust deed, which is similar to the one used in traditional financing. Both documents are then recorded with the local county for public recordkeeping.

1. The seller transfers the title and collects monthly payments from the buyer.

Once the seller carries back the note, the buyer pays the seller in either a lump sum or in fixed monthly payments. The seller then holds onto the note and collects the payments until the final payment.

However, if at one point the buyer stops making their monthly payments, the seller has the ability to legally foreclose the deal and take back the property– the seller can restart the whole process and carry back the note again but to another buyer.

Key Considerations for A More Successful Seller Financing

Now that we discussed the definition and the process of seller carryback, let’s address the elephant in the room– is a seller financing agreement right for you?

For Buyers

Buyers who have a tough time getting financing from a traditional lender benefit the most when doing a seller carryback.

If you have a good credit profile, most sellers are more willing to help you out and negotiate a more reasonable interest rate or offer lower closing costs for you to obtain financing.

Investors who own multiple properties use this strategy to buy more property.  There’s a point when your DTI will max out, and you need to find other ways to add property to your real estate portfolio.

For Sellers

Seller carryback is a strategy also used by real estate investors who are selling property.  Some examples are:

• Mobile homes
• Raw land
• Single-family homes
• Condos
• Commercial property

Offering seller carryback financing carries some degree of risk. However, there are ways to mitigate that risk and keep both parties involved safe.

First, contact a real estate attorney to notarize your paperwork. Next, pull up your buyer’s credit report and comb through their history, carefully checking if they always paid on time and have no problems with excessive debt or previous foreclosures — list it down if they do. You can use a screening service to do this.

One more thing — before finally carrying back the note, it’s a given that you want to have as high of a return as possible, ideally through the down payment and/or interest rate.

Although seller carryback fueled a majority of real estate transactions, a law passed in 2008 (the SAFE Act) limited the ability of both parties to utilize seller financing. This law required that anyone involved in loan origination must obtain licensing as a mortgage loan originator. Validate requirements for your state, and follow the rules to ensure compliance.

Wrapping Up: My Experience with Seller Carryback Financing

Seller carry back is one of several creative real estate financing strategies you can use to expand your portfolio.

Back when I was starting out, my husband and I used seller carry back as a way to finance 3 multifamily properties. Due to some lack of research on our part, we lost a ton of money on our investments since we were eager to jump into the real estate industry.

Looking to get started?  BiggerPockets is a great site for more information and strategies to find seller-financing properties.  You can also check out Reddit’s Real Estate Investing forum to get an idea of what other investors are seeing in today’s market.  

FAQ

What are the risks of seller carryback?

The main problem of seller carrybacks is that the possibility of the buyer defaulting on the payments.

Is seller carryback the same as seller financing?

Yes, “seller carryback” and “seller financing” are the same thing. Both terms refer to the seller becoming the bank, and the borrower the buyer.

What is an example of a seller carry back note?

Let’s say you own a house and you want to sell it for $300,000. A buyer contacts you and wants to make a $60,000 down payment and pay the remaining $240,000 through seller carryback.

You agree and you both sign a note wherein he promises to pay you the remaining balance (plus interest) in either a lump sum or installments. The note is then carried by the property and if the buyer defaults, you get it back.