SELLER-CARRIED FINANCE 101:
PROMISSORY NOTES AND TRUST DEEDS
With interest rates currently well above recent historical averages, real property buyers and sellers have been looking for creative ways to finance property. Perhaps you are a buyer who has fallen in love with a property, but has changed jobs recently, and you do not qualify for traditional lending. Or maybe you are a Seller who has had trouble selling your property, and a potential buyer presents you with an offer, but asks you to finance the transaction.
Regardless of why you need seller-carried financing, you have options. However, those options come with major consequences, and should be carefully considered before anything is put in place.
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In Oregon, there are two main types of seller-carried finance: (1) Promissory Note, and Deed of Trust; and (2) Land sale contracts. Although both mechanisms result in a similar outcome – the seller financing the transaction - the two methods carry substantially different risks that should be understood before deciding on a deal structure.
This article will focus on financing through a Promissory Note and Deed of Trust. Look for my other articles to learn more about Land Sale Contracts.
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Promissory Note and Deed of Trust
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As the name suggests, the primary documents used to finance under this mechanism are a promissory note, and a deed of trust or trust deed. Under this form of seller-carried finance, the seller will execute a deed (not a deed of trust) conveying their interest in the real property to the buyer. The buyer will then have both legal and equitable title to the real estate.
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Simultaneously with the seller’s execution of a deed, the buyer will execute a promissory note and a deed of trust. The promissory note is legally known as “commercial paper” and serves as a document that outlines the financial terms under which the seller is lending funds to the buyer. The “Note” as it is often referred to, includes the amount of money owed (the “principal”), the interest rate, repayment terms, late fees, events of breach, and more.
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The trust deed works in tandem with the Note (which is referenced in the trust deed). The trust deed serves as a security instrument, connecting the obligations under the Note to the property. The buyer of the property is the Grantor under the trust deed and grants the seller/lender the authority to foreclose on the real property under certain terms and conditions.
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This method of seller-carried financing is the same as the traditional method used by institutional lenders, and is how most people purchase real estate. However, instead of a bank or credit union, the seller is the lender.
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The risks involved with being a seller in a seller-carried finance transaction are substantial. The buyer’s creditworthiness becomes critically important, as the repayment terms can extend as far as 30 years into the future – though I don’t recommend that.
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It is extremely important that the trust deed have first priority over all other liens that may result in foreclosure. If a seller-carried trust deed is in second position behind an institutional loan, and the buyer defaults on that loan, the institutional lender may wipe out the seller’s security. Before you know it, the property is sold, and the seller has no way of recouping the funds they lent to the buyer.
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Don’t let this happen to you.
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Another drawback for the seller – the foreclosure process can be time consuming and costly. A seller can either foreclose by filing a lawsuit in Circuit Court, or through the “advertisement and sale” procedures outlined in ORS Chapter 86. Either way, expect to hire a professional to help.
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There are a few ways for a seller to protect against loss. First, have the right documents put in place that give you the legal authority to protect your investment. Next, require a balloon payment (payment in full) within a short period of time – usually 1 to 5 years. Finally, it helps to have a third-party collect payments, calculate interest and principal on a monthly basis, and distribute funds. This is generally called a “collection escrow,” and is a low-cost way to help the whole transaction run smoothly.
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Here are some more benefits and detriments to consider:
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Seller Benefits
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Collect interest on your funds
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Command a higher purchase price
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Tax advantages (deferral of capital gains)
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Flexibility
Seller Detriments
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Potential for total loss of funds
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Longer foreclosure process than Land Sale Contract
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Ongoing collection and monitoring
Buyer Benefits
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Ability to purchase with poor credit
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Take legal title immediately
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Flexible Terms
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Buyer Detriments
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Loss of federal programs to help borrowers at risk of foreclosure
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Generally higher interest rate than bank financing
Every property is unique, and every transaction is unique. The number one thing you can do to protect yourself is hire an attorney to advise you and draft documents – which is usually less expensive than a loan origination fee.
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Howell, LLC Real Estate Law advises both buyers and sellers entering seller-carried transactions, and also represents sellers trying to collect after losing their security interest after a buyer’s default or foreclosure. We prefer to help make sure you are protected on the front end, but we will help you attempt to collect on the back end if you find yourself in that situation.
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Tyler Howell
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(503) 710-2566
Disclaimer: This article does not create an attorney client relationship, and nothing herein can be construed as legal advice.