Personal Business: Smart Money
SELLING THE HOUSE BY FINANCING THE BUYER
Tight money or a sluggish economy can make your home sweet home hard to unload--especially a vacation place. One incentive to offer prospective buyers is a seller take-back, or purchase-money mortgage. That's when you provide financing to the buyer by "taking back" all or part of the mortgage.
The arrangement looks win-win. For the buyer, it eliminates thousands in closing costs--and the buyer may negotiate a better interest rate from the seller than from a bank. The seller gets an annuity that pays out monthly at a higher rate than a CD or Treasury security. Take-backs often range from 5 to 15 years, with a balloon payment of the principal at the end. Monthly payments are based on a 15- or 30-year payout.
Let's say a seller agrees to take back a $50,000, seven-year mortgage at 8%. The monthly payment is $377. If the seller reinvests the payments at 3% a year--the rate of a one-year CD--he will have $86,000 after seven years, including a $46,000 balloon payment. That would amount to about an 8.1% yield. Without reinvestment, the yield is much less. The same $50,000 in a seven-year Treasury note at current rates would get 5.8%.
To make a take-back mortgage pay off, the holder needs the discipline to re-invest. There are other pitfalls to consider as well. You need to investigate the buyer's credit, financial and housing history--and insist on a down payment, so the buyer has a financial stake in the home. But even so, a buyer can default, forcing you into onerous and costly foreclosure proceedings--after which you still must sell the house.
LOCKED UP. The fallout from default can be worse if the seller takes back a second mortgage. That is, the seller makes up the difference when the buyer gets most, but not all, of the financing from the bank. If the buyer defaults, the primary lender will take everything, says Margaret Scott, president of Mortgage Advisory Services in New York. Her client had a take-back second mortgage in one case. "By the time Dime Savings Bank had foreclosed on the house, paid taxes and legal fees," says Scott, "my guy ended up with nothing."
Another problem is that the seller's money is locked up for the length of the loan. You can sell the mortgage in the secondary market to investors, who often advertise in the classifieds. But you'll have to sell at a discount to boost the yield high enough to make it attractive.
Take-back mortgages have fallen off from their heyday in the 1980s because bank loan rates are much lower than they were then. Even so, says Scott, "sometimes it's the only way to make a deal."Pam Black EDITED BY AMY DUNKIN