A seller carry-back is a transaction in which the seller accepts a note — secured by a mortgage — in place of cash, as full or partial payment of the consideration due under a purchase contract. Typically, the seller carry-back is subordinate to the mortgage used by the buyer to fund most of the purchase price.
Here’s an example of how it works: Bob Buyer wants to buy Sam Seller’s house for $100,000. Bob has $10,000 in cash and is able to obtain “bank financing” for $80,000. At closing, the title company collects Bob’s $10,000 down payment and the $80,000 from Bob’s lender. Sam agrees to take a note — Bob’s IOU — for the rest of the $100,000, together with a mortgage to secure repayment of the money. The mortgage securing Bob’s debt to Sam will be recorded in a lien position “junior” or “subordinate” to that of the bank.
Since the total loan-to-value of a buyer’s financing is a risk factor, not all lenders permit subordinate financing. Furthermore, those who do permit subordinate financing may restrict the type of subordinate financing used in a transaction. Thus, it is essential for someone contemplating the use of seller financing to find a lender that is agreeable to its use. That lender will definitely want to ensure that the buyer’s note contains commercially reasonable terms and that the mortgage securing it does in fact get recorded. Otherwise, there is a risk that the buyer is trying to evade the first mortgage lender’s loan-to-value restrictions with a “sham” second mortgage.
Since the Uniform Residential Loan Application that the buyer submits to the bank providing the main financing asks specifically where the rest of the money is coming from, you must disclose that you part of the transaction will be financed by the seller. Failure to do so would be considered fraud — something which you should definitely avoid.
If you are considering a transaction involving seller financing, I would strongly urge you to get a lawyer involved in the drafting of the note and mortgage. As a buyer, it will help make sure that the repayment terms are fair; as a seller, it will help make sure that the terms of the note and mortgage are enforceable.