What is carryback financing?

Carryback financing occurs when a real estate seller provides financing for the property buyer. It’s also known as “seller financing,” and it can violate the contract you have with a traditional lender.

Put simply, a seller agrees to carryback a note and deed of trust, usually in the form of a second mortgage. Instead of using financing from a traditional bank lender, the buyer uses financing from the seller.

This financing option is used when the homebuyer lacks sufficient credit or a deposit for the entire mortgage loan.

If the buyer wants a $100,000 home and can only provide a $10,000 down payment, the buyer may only be approved for $80,000. There is a $10,000 gap leftover in the required mortgage loan for the purchase. This is where the seller can financially assist the buyer. If the $10,000 gap is covered by the seller, then they perform carryback financing.
If the buyer cannot get financed at all due to issues with income, credit, etc., the seller might take the buyer’s payments and continue to pay their own mortgage. They would be required to complete the full purchase loan within a set time or lose the house. This would generally violate the terms of the original loan.

John Kolb, senior vice president of Capital Mortgage Funding, said this financing is completed between the two groups after the fact.

“It is typically done behind the scenes and after closing to make up the difference of what the buyer could not come up with to satisfy the seller’s needs,” he said.

How Can Both Sides Protect Themselves?

This type of arrangement can be hard for both sides. The seller may worry about if the buyer defaults. The buyer may worry about the seller honoring the original terms. This is why Kolb recommends that buyers and sellers go through a real estate attorney and ink a formal contract to protect both parties. This determines how much the buyer is expected to pay, the interest rate, period of time, and much more. Just like you would with your traditional mortgage loan, you’ll set up loan terms potentially including closing costs for legal fees and title fees. 

Mark Olson, a senior legal counsel with Archer Norris, said this type of financing carries a serious risk.

“If this was three to four years ago, you would be out of your mind to do carryback financing,” he said.

Any loan carries a risk of default. For sellers with limited disposable income, a borrower’s failure to repay their debts could have drastic effects on their financial lives. One of the most important things for sellers is to keep in mind their own financial situation. If you have to take out a loan to pay for a partial carryback on the purchase price, you may want to wait for another buyer or renegotiate the terms of the purchase.

Additionally, the carryback financing is not the buyer’s first repayment priority. When carryback financing is carried out alongside a traditional bank loan, the bank-originated mortgage loan is prioritized. The carryback financing is subordinate in the event of bankruptcy, and the bank loan will always be repaid first.

How Can A Seller Evaluate The Creditworthiness of A Buyer?

Olson said there are implications if the seller wants to proceed and assist the borrower. In order to make a sound decision, the seller should research the housing market and the buyer’s financial history and credit score.

The seller should act similarly to a large lending institution. If a bank does not believe the borrower is making a sound investment, or if the borrower lacks the resources to repay his or her debts, the bank will not lend the money.

“The seller has to believe in the value of the property and has to believe that he or she knows where the market is going to go,” Olson said. “If the buyer can’t get the full loan amount, it’s because the buyer has credit problems.” Although minimal, there are a few reasons why some sellers provide carryback financing.

First, carryback financing allows more buyers to qualify for the seller’s property. The seller may still have to pay full realtor commissions upon the original sale date.

Second, because more people are able to obtain financing, the home becomes more attractive to buyers. This can increase the sales price of the property.

Finally, the seller can make a profit on the loan due to higher interest rate costs.

Carryback financing can carry any interest rates or terms, according to Greg Cook, a first time home buyer specialist. Unlike bank financing which offers loans with interest rates ranging from 3 to 5 percent, sellers can provide carryback financing for borrowers with upwards of 8 to 15 percent interest rates. This is laid out in the owner financing agreement. If the owner financing is for the whole amount, this could prevent a transfer of title as that would alert the mortgage company that holds the current conventional loan. It could lead to a faster initial closing, though. If the buyer defaults on payments, depending on the amount, the seller has the right to collect in different ways including foreclosing on the house. This would be a complicated process for an individual, though. Most importantly in some ways, you have to nail down on paper what the principal balance is going in and how much regular payments will reduce said balance.

It is due to this unrestricted, open-ended nature of carryback financing that makes them appealing to some sellers. Cook said when he entered the mortgage business in the 1980s, carryback mortgages were popular.

Despite the risks and relatively small profit margins, seller carryback mortgages do offer positive features during the home buying process, Kolb said.

“They allow room for flexibility and can be crafted to suit the needs of all parties involved,” he said.

Is A Seller Financing Agreement Right for You?

Only the buyer and seller in a certain transaction can decide if it’s the right move for them. While there are benefits, there are also plenty of complications including the creditworthiness of a potential buyer. If a contract is written up, both sides may want to go through traditional steps like an appraisal and the buyer submitting income and other financial documentation such as a credit report or asset statements. All this will help help both buyer and seller make an informed decision. It may also help the buyer secure traditional financing at a later time.

If one or both parties decide it’s not the right choice, the buyer can explore different lender options. Traditional mortgage lenders each have their own underwriting processes. Buyer and seller can also renegotiate the price or discuss a lease option. Realtors and attorneys can play a key role in these discussions. 

Apply for a Loan

If you’re looking for a traditional loan, pre-approval is preferable before you start shopping. Whatever stage you’re at in the purchase or refinance process, enter your ZIP code below to view lenders with cheap loan rates. Sellers have options for faster closing, better interest rates and terms, and much more. This is true whether you’re purchasing, refinancing a traditional mortgage, or refinancing an owner financing arrangement.