4 Dangers of Carryback Loans

Carryback loans can be an effective way to complete a sale in a slow housing market. But there are default risks associated with this type of lending. Consider the following points so you can be aware of the dangers of carryback loans.

Carryback Loans Defined

Carryback loans are also called second loans or seller loans. Very rarely, a seller will carry back the purchase price of a home and offer financing to the buyer. More often, however, are situations where the seller offers the buyer the difference between the agreed purchase price, and the amount of loan for which a buyer can qualify.

As an example, if a buyer can only qualify for an 80 percent loan on a $200,000 home, the seller might offer to carry back the remaining 20 percent, or $40,000, in a carryback loan. This can help a seller sell a home for a price that is higher than the lender's estimated value.

Carryback loans should be executed on legal documents, drawn up by knowledgeable experts or attorneys. The documents should stipulate all of the terms of the agreement, such as; interest rates, payback terms, penalties and default risk, just as with any other loan.

Default Risk

The primary risk of carryback loans is default. In most cases, the borrower was unable to borrower from traditional sources because their risk was high.  The seller's risk is high because if the buyer defaults, the first mortgage will be paid in a foreclosure.  Carryback loans, if they go behind a regular mortgage are paid off only once the lender has recouped their costs.

Late Payments

Late payments are the most common problem with carryback loans. Keep in mind the buyer has two mortgage payments to make. They must pay the first mortgage and the seller carryback loan. Late payments can lead to default, but along the way, the seller with a carryback loan is forced to get the borrower current, which, again, costs time and trouble.

Second Position

In almost every case, carryback loans take second position to the traditional mortgage on a home. If the buyer goes into default and the home is foreclosed on, any proceeds of sale go to the mortgage holder first. If the sale only covers the mortgage, you don't get your money back from the carryback loan.

Fraud or Deception

With carryback loans, you face the same misrepresentation problem many lenders face. As a seller, however, it is difficult to verify the information because a seller wouldn't have the tools to verify the application information. If your borrower is lying to get into the home, you might not know it until the payments stop.