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Dealing With A Default

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Posted On: 12/02/2009

Q: I’m 76. After the death of my husband in 2006 I sold our property. The agreement was that the buyer would pay monthly installments for one year, get financing and pay a balloon payment for the balance at the end of the year. He made a down payment and also was supposed to pay an additional $20,000 after the first six months, which he didn’t. I don’t want to foreclose because I don’t have the energy to move back there and sell the place all over again. I live on Social Security and the monthly payment the buyer sends. I save as much of it as can and pay my own way.

A: If you did not receive the required $20,000 the borrower is in default. You can foreclose or you can sell the note – but what’s the value of a note that is in default and where the underlying value of the property is less than the debt?

You sold property with a seller take-back; that is, you went into the banking business and financed your own sale, most likely because it was a way to sell the property quickly or perhaps at a better price.

You did not walk away from closing with a check because the sale value of the property was a myth. You didn’t get it. Instead you got a piece of paper, some cash and a one-year balloon note – an extremely risky mortgage if the borrower cannot refinance.

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In doing a seller take-back it’s crucially important that both the sale agreement and the loan paperwork are prepared by a real estate attorney of your choosing. In this way you get to set the terms of the loan, just like commercial lenders. Given the terms of your mortgage, is there any chance that the borrower provided the sale agreement and loan forms? Did you review the buyer’s tax returns and credit reports?

You need to show the sale and loan paperwork you now have to a local real estate attorney, typically a lawyer who handles closings. This paperwork will define your rights.

The practical issue is that you’re living on the monthly payments received from the buyer. For this reason you need a strategy that continues those payments and avoids foreclosure if possible.

If the borrower is making monthly payments but has not paid the $20,000, then offer an alternative to foreclosure, perhaps a two-year extension of the loan if the borrower will put up additional cash now. Maybe in a few years the borrower really will be able to refinance.

The monthly payment and the number of months can be adjusted to get the financial result you want – be certain, however, that the current loan agreement is replaced with one written by your attorney and that it does not allow any assumptions or subordinations without your written approval.

You also might want to consider the value of the property as a rental. In this situation you would foreclose and then rent out the home. Local brokers can provide information regarding rental rates and market conditions.

You could, of course, also sell the note. Local mortgage brokers may know investors who would have an interest in such paper, however since note is in default and the security for the note is upside down you’re likely to take a huge loss on the loan. This loss may produce significant tax write-offs – for details speak with a tax professional.

Another alternative might be the use of a land contract. A land contract is an installment sale. The buyer does not get title until some or all payments have been made – or until the property has been refinanced. A land contract can be refinanced with an FHA loan if the property and the borrower qualify.

With a properly written land contract the buyer’s failure to make a required payment would mean the deal is finished. There would be nothing to foreclosure in most jurisdictions because the buyer would not yet have title.

Land contracts are complicated and state rules differ. For specifics, speak with a local real estate attorney before signing anything.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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