About Lem Marshall

Lem Marshall was counsel to the Virginia Association of REALTORS® for 25 years, and general counsel for 16 years. He has represented several local associations as general counsel as well. In 2000 Lem was appointed by Governor Gilmore to the Virginia Real Estate Board, and has been actively involved in every REB regulatory review and revision since 1989. Lem represents licensees before the Real Estate, Contractors and Real Estate Appraiser Boards, and has conducted over 2000 continuing education programs for REALTORS®, attorneys, and title insurance agents.

Seller Financing: A Real Estate Counsel’s Perspective

NOTHING BUT THE SLEUTH: Demystifying real estate and real estate brokerage.

Sellers who wish to make their property more attractive by offering seller financing should keep a few things in mind:

  • In all cases, the seller should act like a lender, that is, the seller should take all the care to investigate the buyer’s financial condition that a lender would. So why not take a typical lender application? This will give the seller information about income, debt and assets that are essential to making a good decision. The seller should ask for a hefty down payment—none of this zero or a few percent down—to provide a buffer against a downturn and to give the buyer every incentive not to default. The listing agent should be able to help the seller understand the application and determine the suitability of the buyer for this de facto loan approval.
  • Sellers should always have a real estate attorney draft the note and deed of trust. It can be modeled after the Fannie Mae forms, but might include expedited procedures for reclaiming the property after default and acceleration, appropriate pre-payment language (if you’re giving the buyer an incentive to pre-pay), and other provisions tailored to the seller’s special needs. It might, for example, contain a pre-payment penalty if the seller is relying on the note for balanced, long-term income at a good rate of return.
  • What about having the buyer provide a lender’s title policy? Subrogation issues will limit the usefulness of the coverage (a unknown defect in title—a forgery in the chain, for example—will be covered, but then the title company would likely have a claim back on the seller under subrogation provisions in the policy for passing bad title to the buyer). It’s a good idea to speak with a title insurer to assess the benefits of such coverage.
  • A real problem arises if the seller has an outstanding balance of his mortgage that will not be retired by application of the buyer’s down payment. Most (but not all) deeds of trust have “due-on-sale” provisions allowing the mortgagee to accelerate the loan and demand full payment on sale of the property. If the seller’s mortgage contains such a provision, and the seller does not get the lender’s consent to deal appropriately with the ongoing existence of the balance, the seller is taking a big risk, as is the buyer.

If the existing deed of trust does not have such a provision, however, the seller can structure the deal as a “wrap-around” deed of trust, that is, the new deed of trust “wraps around” the existing one. The seller would then use the buyer’s mortgage payments to service the existing debt. Wraps are widely used in the commercial world, but they can be tricky; how, for example, does the buyer structure payments to the seller to assure the seller uses the money to service the existing loan? After all, if the seller defaults, the buyer stands to lose the property. The seller, on the other hand, is not likely just to trust the buyer to make the seller’s mortgage payments for the same reason. And if the seller is trying to pull this off without notifying the lender (because he faces a due-on-sale reckoning, for example), the problem is magnified.

The Sleuth suggests strongly that both buyer and seller speak with experienced real estate counsel before embarking on seller financing. It can be enormously beneficial for each, by giving the seller greater market appeal and stable, long-term income, and by affording a buyer with less-than-stellar credit a chance to get into a good home. But there are risks. Don’t try to do this yourself, especially if you’re contemplating a wrap.

And that’s a wrap for this edition of Nothing but the Sleuth.

 

About Lem Marshall

Lem Marshall was counsel to the Virginia Association of REALTORS® for 25 years, and general counsel for 16 years. He has represented several local associations as general counsel as well. In 2000 Lem was appointed by Governor Gilmore to the Virginia Real Estate Board, and has been actively involved in every REB regulatory review and revision since 1989. Lem represents licensees before the Real Estate, Contractors and Real Estate Appraiser Boards, and has conducted over 2000 continuing education programs for REALTORS®, attorneys, and title insurance agents.