When people go to sell their home, the majority will still owe money on a loan from when they bought the property. Since few sellers own a property free and clear, what to do with this underlying lien is an important consideration with owner financing.
A title report from a reputable title company will identify any debts against the property still owed by the seller or any prior owners. In a traditional transaction, the seller’s liens against the property are paid off at closing from either the cash funds deposited by the buyer or the funds advanced by the lender for the buyer’s new loan.
With a seller-financed transaction it is unlikely the buyer will deposit sufficient down payment funds at closing to pay off the underlying liens from the seller’s proceeds. If the seller’s liens are to remain after closing, also known as a wraparound, there are several important considerations.
First, most loan documents contain some type of “due on sale clause.” A due on sale clause states that if the property ownership is transferred the lender can call the outstanding balance plus any accrued interest due and demand immediate payment in full.
There are many creative strategies that have been employed to avoid triggering a lender’s due on sale clause. The use of unrecorded real estate contracts, purchase by a trust entity, and use of third-party administrator are just a few.
While there are no guarantees, from a practical approach, lenders seldom exercise their due on sale clause provided the payments are received timely and other note terms, such as current taxes and insurance, are in compliance. Nonetheless, the lender has the right and this has the potential to cause subsequent problems. A competent attorney or title agency can provide wrap around disclosure language for the documents, making all parties aware of the situation.
Second, it is imperative to make arrangements for timely payment of the seller’s underlying lien from the purchaser’s monthly payment. It is a trusting fool that sends their payment each month directly to the seller and hopes the seller promptly sends on their portion to the lender. What if the seller forgets, or worse, gets in a financial bind and uses the money that month for other expenses?
When using seller financing with a wraparound situation, it is advisable to use the services of a third-party escrow or servicing agent. The third party will receive the monthly payment on the note from the new purchaser, apply to principal and interest, and then disburse the appropriate payment to the underlying lien holder, with any difference or overage remitted to the seller.
For more helpful ideas on seller financing with underlying liens please visit the bookstore for Personal Profit Series: Notes – Your Complete Money Making System to Buying, Referring, Creating and Holding Real Estate Notes!