The Risks of Seller Carry Back Strategies

Straight Lease – A rental for a specific period of time.

Generally incurs a negative cash-flow along with unrecoverable costs of management, maintenance and vacancies. No chance for elevated income.

Lease Option (L/O) – A unilateral agreement to sell with bargain terms at a future date.

The lease option violates a lender’s due-on-sale clause. A lease option (if an option fee is taken or rent credits given) can lead to an inability to evict a defaulting tenant. Such a tenant in default can claim having “Equity” in the property, and in so doing, force a judicial foreclosure process versus an eviction. This can afford him/her months of free rent while the litigation rages on. As well, terms can be changed on a whim relative to buy-out provisions, repairs, equity credits (rent credits), etc.: all requiring extensive, expensive, legal action to rectify.  I don’t think lease options are great for buyers many times, exposing them to risk of losing their option money if prices depreciate and/or the seller files bankruptcy and the house is sold by the BK trustee to satisfy creditors.

Contract for Deed (CFD) – The CFD is essentially a “Lay Away Plan.” The property’s legal title is relinquished to the vendee (buyer) only after all debt has been paid off: i.e., there is no legal ownership of the property until it’s completely paid for.

The CFD is a direct violation of a lender’s due-on-sale clause; there is no means for eviction; the vendee (resident/buyer) holds an “equitable” interest in the property, allowing only for foreclosure, ejectment and quiet title in the event of a breach of contract. Further, any parties’ creditor liens, lawsuits, judgments, marital dispute litigation and tax liens attach to the property, and the death of any party throws the property into probate.  The CFD no longer allows a seller to defer capital gains, and is not used in CA to my knowledge.

The “Wrap” or All Inclusive Deed of Trust (AITD) – In a “Wrap-Around Mortgage” a seller creates a mortgage loan that is equal to or greater than the current loans on the property. Then from the buyer’s single monthly payment to the seller, the underlying junior loan payments are made (usually leaving a positive cash flow for the seller).

A “wrap” violates the lender’ due-on-sale clause; there is no means for eviction in the event of default; the resident/buyer holds an “equitable” interest, necessitating foreclosure; any parties’ creditor liens, lawsuits, judgments and tax liens attach to the property; and the death of any party throw the entire property into probate.  May be fine if neither party would be financially harmed by the bank exercising it’s due-on-sale rights.

The Equity Share (ES) – A shared ownership of real estate, wherein two or more parties hold title as tenants-in-common. Typically, one of the parties makes the down payment while the other lives in the property and makes the monthly payments.

An ES violates the mortgage lender’s due-on-sale clause; there is no means for eviction of an errant tenant/buyer in the face of default; the resident/buyer clearly holds “Equity” thereby forcing judicial foreclosure, ejectment and quiet title action in the event of a breach of contract (versus eviction). Any party’s liens, lawsuits, judgments, marital dissolution litigation and tax liens attach to the property; the death of any party puts the property into probate.

Subject ToThis is an “assumption” of mortgage payments subject to a loan’s existing terms (not a formal assumption of the loan, just taking over the payments)

Subject-To is basically a generic term that can be applied to any of the above; and like the above, a Subject-To violates the lender’s due-on-sale clause; prevents one’s right of eviction of a defaulting tenant/buyer; it conveys Equity; it jeopardizes title; it invites disastrous disagreement and litigation between parties; either party’s business, personal and legal actions attach to the property, thereby seriously negatively affecting the interests of the other party.  As a professional, I never counsel sellers to get into these.  If you’re an investor, then you can’t lose, all the risk is held by the seller whose name is still on the loan, so many investors still use them to acquire properties.

The Equity Holding Land Trust Transfer System

Virtually none of the downsides, but all of the benefits and protections of Seller Assisted Financing.

  • There is a defensible position against acceleration
  • Simple eviction rights are preserved upon tenant/buyer default
  • A seller’s property is vested with a 3rd party trustee
  • Income tax benefits can be conveyed to a tenant
  • No party can act independently of the other
  • No party can jeopardize title (accidentally or on purpose)
  • The property is shielded from public view and is well insulated from lawsuit, creditor judgments, tax liens, bankruptcy, marital dispute and probate on behalf of either (any) party to the arrangement.

Problems: The tenant/buyer could default, but if they do, they are evicted, not foreclosed upon. The seller regains possession of the property much more quickly and inexpensively, which helps mitigate the risk and potential damage upon default. There may be penalties and/or sanctions imposed upon the defaulting party. The property could lose value over the term of the agreement, necessitating a future sale at a loss or an extension of the agreement.