If you're buying a house this year, or selling one, cash is likely to be a problem. Banks have tightened up on mortgages, forcing buyers to make larger down payments. Many buyers, even those with high incomes, may not have enough cash to close a deal.
In a climate like this, sellers have two choices -- either lower the price or creasingly, sellers are choosing to help.
Assume that a house is for sale for $80,000 in cash, but the buyer is $10,000 short. Instead of losing the sale, the seller may agree to let the buyer pay the $10,000 in installments, charging the going rate of interest and taking as security a second mortgage on the house.
In another case, the seller may decide to give the entire mortgage himself. He accepts $14,000 in cash plus a mortgage for the remaining $66,000. Older people moving from a house to an apartment, are often interested in this kind of arrangement because of the regular interest income it provides.
there's a tax angle, too. If you accept no more than 30 percent of the house's price in the first year, you have an installment sale -- which allows you to spread payment of the capital gains tax over the life of the mortgage.
The details of these mortgages vary from state to state. In New York, they're called purchase-money mortgages; in California, they're called carrybacks. Richard Farrer of Magna Mortgage Co. in Castro Valley, Calif., says that 8 to 10 percent of his transactions now include a carryback.
As money tightens he thinks that number will grow. Irving Price, of Hudson Michael Realty in Hudson, N.Y., says that 85 percent of his transactions of $100,000 now require some sort of purchase-money financing.
The only trouble with these arrangements is that they forge a lingering bond between buyer and seller that one of them may come to regret. Some of the things to consider:
(1) The buyer may not be as credit-worthy as he or she looks. In states that use deeds of trust for real estate transactions, a house can generally be reclaimed quickly if the buyer defaults. But states with foreclosure proceedings can tie up properties for quite a while. A house could be vandalized while it's standing empty, causing its value to fall.
Price recommends a full credit check on the buyer, and letters of recommendation from the buyer's bank and employer.
William Ellis, head of the Shannon & Luchs real estate company's residential offices in this area, says that a purchase-money mortgage shouldn't be given for more than 80 percent of the purchase price.
(2) The seller may not be around when the buyer needs him or her. Say, for example, that you buy a house, get a purchase-money mortgage, then pay it off. You'll need a signed mortgage satisfaction form in order to remove the lien from the house. But what if the seller is senile, or in Pago Pago? You may not be able to sell the house until the paperwork is in order.
Price advises that you have a signed mortgage satisfaction form filed in advance with the seller's lawyer, giving the lawyer authority to release it when the mortgage is paid. Also, have a clause permitting payment of the mortgage in advance.
(3) Agree on exactly what property is covered by the mortgage and provide that the buyer cannot sell any of it off. If the buyer plans to subdivide the land and sell a piece, the contract should specify which part of the property can be sold.
(4) Every year, buyer and seller should formally agree on how much of the loan remains to be paid. Otherwise discrepancies and develop.
(5) A small second mortgage should be payable within five years. When the seller grants a first mortgage, however, he or she generally will have to write it for 20 to 25 years, during which time interest rates may rise.
As an inflation hedge, provide that the loan may be called after only five years, at which point the buyer would have to refinance. Buyers don't like calls, of course. Whether one is included in the contract depends on which side has the stronger hand in negotiations.
Some buyers try to write the mortgage agreement themselves, or if state law allows, let the real estate broker do it. In view of all the potential problems, better see a lawyer for a mortgage contract that fully protects your interests.