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If I Carry Paper, What Happens if the Buyer Quits Making the Payments?

Well, the first thing you do is sit down and try to have a friendly conversation, maybe over the drink, or a game of poker.  A little diplomacy can go a long way.

If they don’t bring out the briefcase stuffed with greenbacks right away, you could also offer to introduce them to your cousin Al . . . every respectable family has one of these.

And if none of these soft approaches work, then you do what all lenders are doing right now . . . ask Obama for a handout.  It’s plain un-American to take a risk and lose! Investors need to be protected.

Actually, I do plan on getting serious starting right . . . . . . . . now.

When you sell a piece of property and carry paper (carry back a note, take back a note), you become the beneficiary.  Under ‘normal,’ or at least typical, circumstances, the beneficiary is a bank, an institutional lender.  But in seller carry back transactions, there are no third party lenders.

The seller becomes the bank

You, the seller, are ‘lending’ the buyer your equity in the property.  (Read about becoming the bank on your own property, especially as a retirement planning strategy).  You are taking a down payment and agreeing to let them pay you over time for the rest, with interest, of course.

So . . . you, as the lender on property that you previously owned, will do whatever banks usually do when they stop receiving payments:

  1. Start the foreclosure process to regain possession of the property
  2. Work out a loan modification with the buyer/payor
  3. Sell the defaulting note at a steep discount 

None of these sound very fun, do they?  (Unless, of course, you got a 50% down payment and now get to take the property back for an opportunity to sell it for full value all over again).

Foreclosure is one of those ‘F’ words that causes people to get a bit queasy, but really, in most circumstances, it’s not that big of a deal.  How strenuous the process is depends largely upon what kind of a down payment you received at closing.

The time to worry about a loan is before you make it

If you got a large down payment (20% or more), then you should have enough protective equity to get you through the foreclosure process without a loss.  Protective equity ‘protects’ you against loss in case of default. That’s why you get the biggest down payment from a buyer that you possibly can.

But I don’t want to have to foreclose on someone!!!

If you just can’t stand the idea of potentially having to foreclose to protect your interest, here are some alternatives:

  • Sell the note at a discount – even non-performing paper can be worth something on the secondary market, but you can choose to sell the note long before there is a problem.  Some sellers use seller financing to get a property sold, then they season the note for a while (collect a few payments) and sell it to someone else so they don’t have to worry about anything down the road.
  • Put the property in a land trust before you transfer a beneficial interest to another party – besides allowing you to evict, rather than foreclose upon, a defaulting ‘buyer,’ this will also protect you from an increased tax basis should you end up taking the property back.

What happens when the buyer quits making the payments is dependent upon how you set the transaction up in the first place.  This will make all the difference.  That’s why you will usually want a note professional/seller financing consultant to help you put your deal together.

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