Caveat: What follows is an attempt to explain two types of seller carry-back financing in Oklahoma. It is written by a lawyer with the intent of explaining what seller carry-back financing is, and the different advantages and disadvantages of two different instruments. It should not be relied upon as legal advice in your particular situation. The facts of your particular situation matter and you should always discuss with your own attorney.
What is Carry-Back Financing?
Real Estate is commonly purchased with borrowed money. In the most common transactions, a seller conveys title to a buyer who immediately executes a mortgage and promissory note in favor of a lender. In most arm’s length transactions, there is no connection between the seller and the buyer’s lender. The seller’s interest in the property usually ends after executing the deed; however, there are ways that the seller can function as the lender.
In many cases where I have assisted on these transactions, they have been intrafamily. I have helped grandparents or parents convey property to a younger generation and carry-back a mortgage on the property that will provide the older generation with a small income stream in retirement while allowing their grandchildren to own a home without applying and paying for bank financing. Another common scenario is a landlord selling property to an existing tenant that has been occupying and renting that property for a while.
First and foremost, this is essentially a financial or business decision that a seller needs to make on their own. As an attorney, I can explain the mechanics of how everything works, explain the various risks, draw up the necessary documents, and oversee their execution, but ultimately, the seller has to make the decision of whether lending money against real estate is right for them.
Real Estate Financing can be rather complex, but this is a basic blog post, so I am going to focus on the two most common seller financing options in Oklahoma: (1) seller carry-back mortgage and note; and (2) contract for deed.
Traditional Note and Mortgage
At the closing the buyer will tender any down payment that is required under the purchase and sales agreement. The seller will execute a deed in favor of the buyer, conveying all of seller’s interest in the property. The buyer now owns the property. The buyer will execute a mortgage and a promissory note in favor of the seller, representing the portion of the purchase price being financing. The Promissory Note is the contract between buyer and lender that sets out all of the detailed terms of the loan, terms of repayment, and the lender’s remedies if the buyer defaults. The Promissory Note is not filed of record, but the lender must retain a copy of it to present to the court if it becomes necessary to foreclose the loan in the future, or if the lender wants to assign the loan to someone else in the future. The Mortgage is the contract between the buyer and the lender that attaches the debt evidenced by the Promissory Note to the real estate owned by the buyer. This is filed with the County Clerk to provide notice that the lender has a first priority lien on the real estate.
When a buyer borrows money from the bank, there is not much to negotiate with the note and mortgage. The lender holds all of the power and the borrower is essentially given the option to accept the lender’s terms or apply somewhere else for a loan. While the seller/lender will usually still have the better bargaining position in these kinds of transactions, their arms are not as tied by the lending institution’s underwriting standards and lending guidelines, which means when two private individuals enter into a note and mortgage, the lawyer drafting the instruments can customize them to meet the parties’ needs.
There are multiple fees associated with this process. While your title company will probably draft the deed as part of their fee, you should have a lawyer draft the mortgage and note. Most title companies do not want to take on the liability for drafting these kinds of instruments and they will often direct you to an outside lawyer. Ryan is happy to help. In addition to the legal fees for drafting the documents, there are recording fees and taxes. The County Treasurer will charge a $5 certification fee plus a tax based on the term and amount of the mortgage loan. The County Clerk will require that transfer taxes on the real estate be paid in the form of “Documentary Stamp Taxes.” After both of these taxes are paid, both the mortgage and the deed can be recorded after payment of an additional recording fee for both documents.
Contract for Deed (“CoD”)
The Contract for Deed (hereinafter “CoD”) combines elements of a purchase and sales agreement, loan documents, and incorporates the occupancy and use paragraphs you might find in a lease. Under a CoD, the seller and buyer are entering into an agreement by which title remains in the name of the seller, but the buyer takes immediate possession of the property. Over the course of a period of time set out in the CoD, the buyer will make payments to the seller until the obligation owed under the CoD has been paid. At that point in the future, the seller will execute a deed in favor of the buyer, releasing any further obligation of the buyer under the CoD.
This means that if the seller has a credit card judgment or a tax lien filed against them, it attaches to the property because it is still legally titled in the seller. Failure to pay property taxes, mowing liens, and dilapidated structure liens will also all be filed against the name of the seller. On the flip side, judgments and liens against the buyer will not attach until the CoD has been completed and the seller executes the deed to the buyer. A buyer who may not otherwise qualify for traditional financing can take possession of real estate under a CoD and start making installment payments to the seller.
Theoretically, a Contract for Deed incentives both parties to take care of the property. The buyer will eventually own the property and should care for it more than a tenant who has no ownership stake. The seller is still in title and wants to avoid liens for failure to pay real estate tax, mowing, and dilapidated structures.
However, a CoD is not always the simple, one size fits all solution it may initially appear to be. Oklahoma law treats that monthly installment payment as an ownership interest acquired in the property. The buyer does not have legal title, but they have equitable title, and Oklahoma law explicitly requires that a CoD be construed as a constructive mortgage that must be foreclosed in Oklahoma district court. That means landlords can’t technically get rid of a buyer under a CoD with an eviction, they must resort to the more costly and time-consuming foreclosure process. A foreclosure can be avoided if the buyer executes a deed in favor of the seller, but that deed needs to be dated and executed after the last installment payment. Remember, the buyer is acquiring an ownership interest with each payment. Some sellers try and circumvent the foreclosure requirement by having the buyer sign a quit claim deed up front, but the buyer does not own anything at the time they are executing the conveyance.
Historically, CoDs have gotten a bit of a bad reputation in Oklahoma because sellers used them unscrupulously in prior decades. Buyers were not always aware of the distinction between the legal and equitable title described above. Additionally, many poorly drafted CoDs did not place any restrictions on the seller’s ability to encumber the property. Many sellers would simultaneously borrow money from banks against the property they were selling under CoDs. Oklahoma statutes do not require a CoD be recorded until the seller goes to foreclose it. This allowed sellers to execute CoDs, never record them, and then go and borrow money against the same property from a bank that did not know about the CoD. (As a side note, never lie to a bank.) In situations where the seller failed to meet its own obligations under those loans, the buyer under the CoD might unexpectedly find themselves subject to a foreclosure or dragged into the seller’s bankruptcy proceedings. Parties acquiring property under a CoD should seriously consider retaining an attorney to review the document to make sure that their rights and interest in the property will be protected and that they understand every term that they are agreeing to. From the buyer’s point of view, a good CoD will clearly require the seller to convey title by warranty deed, free of any mortgages, judgments, or other liens.
A CoD is a single document instead of the separate deed, mortgage, and note discussed above. It will likely be cheaper to have it drafted than those three instruments separately, and the single recording fee will be cheaper than the multiple fees paid to recorded the deed and mortgage. However, the upfront savings are minimal when considered over the life of the loan and that should not be your primary motivation for choosing one instrument over the other in a simple residential context.
In conclusion, I want to emphasize what I said earlier. Whether you carry back seller financing and what type of instrument you use are ultimately decisions that the seller/lender must make. When you agree to accept payment in monthly installments over a period of years instead of a lump sum, you have the opportunity to make more money because of the interest on the loan; however, you are also now bearing the risk of not being fully paid back if your buyer defaults. Depending on the value of the real estate and the amount of payments made up until the point of default, it’s possible that you will recover your entire investment and legal fees in a foreclosure action, but that takes money and time, and more importantly, it’s not guaranteed. Ultimately this is a risk and business decision that each seller has to make based on their own situation