Risks of a Seller Carryback Loan for the Seller:

As in any sale and purchase of real property, there are inherent risks of potential litigation. None are more so than in a seller carryback loan. The risks to the seller are exacerbated if the seller is not in a first secured position on the carryback. In this case, the seller, in order to protect his or her junior secured position, most likely will have to keep current all defaulted senior secured loans or face the possibility of being wiped out in a foreclosure proceeding. If the property forecloses, the seller will have no recourse against the new buyer for the carryback loan fulfillment as a matter of law and will lose what is owed under the seller carryback.

The greatest concern in the seller carryback loan is a default by the borrower buyer. Should a buyer in a seller carryback transaction default on the loan, the seller is forced to foreclose on the security if the buyer will not voluntarily cure the default. If the seller forecloses on the security and ends up with legal title to the secured property, evicting the buyer post foreclosure can be both expensive and time consuming.

Another potential seller carryback risk is if the buyer-owner makes alterations to the sold property after the purchase is final, and foreclosure happens prior to the repairs being completed. If the seller with the carryback loan takes back legal title, he/she will have repairs to complete that were not anticipated when the trust deed securing the buyer’s promissory note to the seller was recorded. Repair costs could be in the tens of thousands of dollars and may need to be completed prior to attempting to resell the property, to recover the value of the seller carryback in addition to the payoff value of a potential first secured position loan.

There is also a significant seller carryback risk when the full loan payoff is due. The buyer may make nondisclosure claims against the seller for the first time as a means to renegotiate the terms of the secured promissory note. These claims can center around undisclosed water intrusion issues, undisclosed foundation issues, and similar issues, where the buyer contends that such information was known by the seller well before close and was material to the price and desirability of the property.

There are situations where the seller is in a second secured position on a $100,000 or more carryback, and the seller cannot keep the first secured lender on the parcel current when the buyer-owner defaults. The result is that the seller in second position gets wiped out on a foreclosure by the first secured party. 

Damages would be loss of the principal amount of the carryback, prejudgment interest, and assorted costs incurred in protecting the security under the second trust deed.

How the seller is protected in a Seller Carryback Transaction (details are for California)

In the event that you (seller) are considering a seller carryback as a means of selling your property, check with your real estate broker or state’s real estate commission to obtain a “Seller Financing Addendum and Disclosure” or similar disclosure form. Should you opt to do the seller carryback; you and the buyer will need to sign, date, and initial this disclosure form well before escrow is closed. Save this signed form in your file. 

The Escrow Company should then be notified, suggesting that the Trust Deed being drafted by title have provisions within that:

• The buyer is to keep all property tax payments current.
• The buyer must have written permission from all secured lien holders (senior/first and junior position lenders) before any alterations to the sold property exceeding one thousand dollars ($1,000.00) are made.

However, check with your state regulations to ensure you follow any state specific guidelines for seller carryback transactions.

The last thing the secured parties want is to foreclose on a home that has unfinished and perhaps unpermitted construction.