What is carryback financing?

Housekeys hands home
Carryback financing occurs when a real estate seller provides financing for the property buyer.

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.

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.

Kolb recommends that buyers and sellers go through an attorney and ink a formal contract to protect both parties.

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.

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 and the bank loan will always be repaid first.

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.

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.

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.