Achieve Homeownership with an Owner-Carried Second Mortgage

Motivational speaker Zig Ziglar once said, “Failure is a detour, not a dead-end street.” Remember those words if your lender doesn’t approve your mortgage loan. With a little creativity and a motivated seller, you can still buy that dream home.

Owner-carried second mortgages, also called seller carrybacks, are more prevalent during periods of tight mortgage lending – like now. In this market, you may have seen several references to “owner-carried financing” in home sale ads. The term can be somewhat misleading, because it generally does not mean that the homeowner is willing to finance the entire purchase. 

Specialized second mortgage solution

A typical owner-carried second mortgage is designed to close the deal when you, the buyer, don’t have the cash down payment required by the bank. If, for example, you only have 10 percent available for a down payment, and the bank will only finance 80 percent, the owner/seller might step in and finance the remaining 10 percent of the purchase price.

The term will likely be short -- a willing owner may agree to a seven-year maturity, at most. The interest rate is negotiable, but you can expect it to be 8 percent or more. You might also have to pay a higher purchase price.

If these terms sound overly restrictive, remember the risks that the buyer absorbs -- if you don’t pay, the buyer has to take legal action. This can be expensive and only marginally effective, particularly considering that the buyer will be holding a secondary lien position. You may be able to gain some leverage in the negotiations if you can put up other personal or real property as collateral.

Before you get too deep into the negotiations with the seller, communicate with your lender. The bank will have to approve the second mortgage, because it will impact your ability to pay on your first mortgage. Ask for the lender’s approval in writing to avoid any last-minute surprises. 

Playing with numbers

For discussion’s sake, let’s say you want to purchase a $300,000 home. Your lender will finance $240,000, you’ll put down $30,000, and the seller will carry $30,000 as an amortizing second mortgage. If the second mortgage carries an interest rate of 9 percent and a five-year maturity, the monthly payment will be about $623. That’s in addition to your first mortgage payment, plus mortgage interest, insurance, and taxes.

The right circumstances

An owner-carried second mortgage is not an inexpensive form of financing. However, in certain circumstances, it’s a very reasonable solution. This strategy works well, for example, when you’re awaiting a large inflow of cash. Maybe you have another home to sell, or you’re expecting a five-figure bonus from work. Buy the home you want now, then pay off the second mortgage when the money comes in.

Creativity and motivation go a long way in a home sale transaction. When you and the seller are motivated, you can create a viable detour and achieve your dream of homeownership.