Why Seller Financing Should Be a Last Resort

Unfortunately, your options are limited. If there were no second trust (i.e., the home equity loan), your borrower could give the property back to you by way of a "deed in lieu of foreclosure." But that would mean that you would be stuck with the home-equity loan.

There are two paths you should explore. First, sit down with your borrower and try to work out an amicable deal. I know that you want the money to buy that new house, but I don't think that is going to be possible. You may want to extend the term of the loan, say by one or two years, and at the same time increase the interest rate so that, at least, you will be getting a larger monthly mortgage payment. Perhaps in a year or so, the real estate market will bounce back.

You or your lawyer should also talk with the bank that made the home-equity loan. Explain that if you cannot work something out, you will foreclose on the property in August. Because that would wipe out the bank's security in the house, the bank might be willing to work with you and the borrower. For example, the bank could buy the promissory note your borrower gave you. The bank would then be in first-trust position.

The bank may be willing to entertain this suggestion, but it is unlikely to buy the loan at face value -- for instance, it may offer you 75 percent of the value of your $275,000 promissory note. You then have to make a business judgment: Will you make out better if you foreclose on the property?

You have to determine the true value of the house in today's market. If it is still worth about $500,000, then perhaps foreclosure will be your best bet. You will start the bidding at the foreclosure sale at $300,000 (this will pay you the full amount of your loan plus the costs of the foreclosure), and perhaps someone will get a good deal.

But the lower the value of the house, the lower your chances are that someone will buy it. If no one shows up at the auction or if there are no decent bids, you will end up owning the house. I seriously doubt that you want that to happen. You do not want to pay the real estate taxes and the insurance on this property, with no certainty when you will be able to resell. In addition, you would probably have to take legal action to evict your borrower.

Seller financing can be a good selling tool but should be used as a last resort. You have a serious problem, with limited solutions. Unfortunately, you will have to make some compromises because I suspect that you will probably not get back all of your money.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site, www.kmklawyers.com.