“Taking Back” a second mortgage is when you buy a home and the seller “loans” you some of the money they need in order to buy the property This can be both an effective selling tool and a good “investment”, however, if the transaction is not handled properly, it could be an expensive and major financial blunder. Always remember to cover your assets, and also remember that you had better cover the assets of the seller as well. If you try to pull a fast one, I guarantee that eventually you will get caught, and the courts well almost always side with the “poor defenseless owner” instead of the “slick expert real estate investor”.
Before we get to the contract, let`s look at what leads up to it. The idea behind taking back a mortgage is fairly simple. Let`s say you`re buying a home for $100,000 and you have $5,000 to put down and can get an $85,000 mortgage. That means you are still $10,000 short. If they really want, or need, to sell the home “right now,” they could “loan” you the $10,000 in the form of a second mortgage.
Usually I make the pay-off period between two & five years, but it can be whatever you want; it is all part of the negotiation process. I always shoot for “No Payments and No Interest until I cash out when I resell the home to an end user. My justification for this is simple: If I am going to help the seller out by removing the problem of two mortgage payments, one at his old house and one at his new house, it is certainly fair that he not stick me with two payments, a first and a second. Besides, although he is in second position, it still gives him a secured interest in the home until I get it sold.
If you DO set up a second with payments now, you need to let them know that once they start receiving mortgage checks, the payments become part of their income, which translates into additional IRS paperwork and, very likely, taxes. Many times, this is a good reason for them to take the no payments no interest scenario I suggest in that long term capital gains ( more than 12 months) of $10,000 will be taxed at only 15%, whereas if the payments are considered income and they are in the right tax bracket, they could be taxes as high as 30% or more.
To cover yourself, it would be good to go over the terms of the mortgage with your seller. First, they must be aware that the first mortgage is ahead of them when it comes to getting paid. If you default, they might not get paid.. If the property is foreclosed by the first lender, the primary lender has first claim on any proceeds from its sale to recover the unpaid debt, plus any penalties and unpaid interest that accrued as part of the foreclosure, as well as court costs and legal fees. Of course you need to assure them that you will not default
If you use this sort of vehicle, make sure your real estate attorney prepares the document for you, and as I mentioned earlier, in the spirit of transparency in business make sure you fairly cover both yourself and your seller. There are enough deals out there for everybody who wants to do the work to become a millionaire. I have walked away from many deals, but still I prosper and I believe it is because I think in these terms, “everybody wins or we don’t do the deal”.
