Seller carry-backs on residential property

     The phrase "seller carry-back" refers to a transaction in which the seller of real property defers collection from the buyer of some portion or all of the price of the real property and takes a promissory note from the buyer for the amount due, secured by a mortgage or deed of trust on the real property.   In the context of personal property security, the same concept is referred to as a purchase money security interest (although this phrase also describes a loan secured by the property being purchased which is made by a third party to the debtor to finance the acquisition of property). 

     There may be several reasons why an owner of residential property would consider carrying back some of the paper in connection with a sale of a residence, even if its security position is subordinate to a primary lender. The purchaser may be unable to obtain sufficient financing from an institutional or other third party lender, either because the purchaser's income or credit, or the lender's appraised value of the property do not qualify the purchaser for the amount of loan sought. Anxious to sell and not optimistic about other offers, the seller may be willing to finance the difference. Alternatively, or in addition, the seller may wish to defer capital gain taxes by deferring payment of some of the purchase price, or the rate of return on the purchaser's note may compare favorably to or exceed the rate of return on other potential investments.

     However, given the anti-deficiency rules of Cal. Code Civ. Pro. 580b, the counselor should advise the seller of residential property to carefully weigh these advantages against the potential adverse consequences of the debtor's default. Because of anti-deficiency rules, if, upon default, the seller is sold-out by a sale on a senior deed of trust, or if the seller's own foreclosure does not net value equal to the amount of the debt, the seller sacrifices the balance. Thus, for example, a retired couple who have recently sold their home, carried back a substantial note, and moved into a retirement community, may see their retirement investment evaporate.

     The seller who carries back can take some steps to mitigate this potential harm. Upon the debtor's default on the seller's note, the seller should non-judicially foreclose. By credit bidding at its own foreclosure sale, the seller can regain title to the property (subject, of course, to any senior liens) and hope to resell the property to another purchaser for an amount which will give it at least as much as it would have obtained had the debtor not defaulted. If the debtor has defaulted on a note secured by a senior lien, the seller should reinstate (recall Commentary.Reinstatement) the defaulted note and, because a default on the senior note will typically constitute a default on the junior note, the seller should then initiate non-judicial foreclosure with the same hope. If it doesn't reinstate, the holder of the senior lien will foreclose and the seller will be sold out if, as is likely in most cases, it does not have enough funds to either redeem or purchase at the senior foreclosure sale. Even reinstatement, however, may require a significant sum. Accordingly, the counselor should advise the seller considering a seller carry-back that it would be prudent to set aside, either from the portion of the purchase price that it does immediately receive at the time of sale of the property or from other assets, enough funds to either assume payments on a senior note or reinstate a defaulted senior note.