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Law Offices of Ronald W. Rutz
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February 22, 1999: Pitfalls of Carrying Back a Loan

Q: If I carry back the loan on the house that I hope to sell, what should I look for in the paperwork to protect myself?

A: Many seniors seem to have your same question after being advised by their financial advisors or realtors to finance a sale by not being cashed out at the closing but instead taking a promissory note and mortgage. The first point is not involved in the technical legal documents but is critical nonetheless. Try not to have your loan be more than 75% of the quick resale value of the property. That way, if you need to take back the property, you will have some cushion to absorb the foreclosure costs (around $5000) and resale expenses (rule of thumb is normally 10% of the sales price). At least you then have a good chance of getting all of your money after taking the property back and then selling it.

It might be wise to have the note balloon (the balance becomes due and payable) after three years or five years. Otherwise your money may become locked in at a rate of return that is a much lower total return (both interest and appreciation) than you can otherwise receive. Also, the promissory note ties up your money so you can not use it if desired or if needed.

The secured document (mortgage or deed of trust) should have a "due on sale" clause so your buyer can not pass on his or her "good deal" as part of a future sale. You might want to help your buyer, but becoming the "banker" for future purchasers is usually neither intended nor desirable.

The grace period for a late payment should be short and the necessity to give written notice and thereafter a time period to cure should be reduced to one time only or completely eliminated. Some buyers purposefully are late and will attempt to delay loan payments as long as possible, whip sawing the lender by continuously being late, triggering the need for written notice before the late payment is technically due, and then paying at the end of the period to prevent foreclosure proceedings, all the while failing to make the next payment and forcing the written notice cycle all over again.

It might sound hardhearted, but you are committed to the terms of the loan documents when you sign. It is better to be in a position to cut some slack in order to help the buyer than to be caught up in one of these seemingly endless cycles.

There are other important points but space restrictions mean stopping here. Remember when you carry back, you become the banker so the documents should be written from your perspective and in light of the worst case scenario. Be sure that your realtor and financial advisor (who are supposed to be representing you) understand that.

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