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Purchase Money Financing: Not Just for Homeowners

August 03, 2022

Gary Kaleita

In recent years, many property owners have refinanced their mortgages to take advantage of low interest rates. When interest rates rise, buyers may prefer to assume a seller’s existing loan since new loans have higher interest rates and require significant closing costs. However, a buyer can’t always come up with the remainder of the purchase price in cash. This is often the case if the seller’s loan has been paid down or the property’s value has risen and created a significant amount of equity in the property.

The buyer may then propose that a seller take back a purchase money mortgage for the portion of the seller’s equity that the buyer can’t pay in cash. While this scenario is more common in residential transactions, it can also apply in commercial transactions.

If you are a seller who agrees to take back a mortgage on the sale of your property, it’s important to understand that your mortgage will be junior to any existing first mortgage that is not paid off at closing. Should the buyer default on the first mortgage, your second mortgage can be foreclosed and extinguished. If the property doesn’t yield enough money at the foreclosure sale to pay you off, you could end up losing that portion of your equity.

To help minimize your risks in taking back a purchase money mortgage, there are several factors to consider when structuring the deal.

  • Make sure the buyer has good credit and can afford to make all mortgage payments.

  • Ensure that the buyer pays enough cash at closing so that they have some equity of their own in the property. A buyer who finances the entire purchase price frequently has no incentive to keep up the property or continue to make payments if they experience financial difficulties.

  • Once you’re comfortable with the buyer and the amount of the new mortgage, make sure your existing mortgage isn’t due on sale and doesn’t prohibit second mortgages. If that’s a problem, you will need to get the lender’s consent.

  • See if your lender will agree to release you from liability at the sale. Many first mortgages allow this if the buyer qualifies to assume the loan. Without a release, the lender can still hold you liable after you sell your property if the buyer doesn’t make the first mortgage payments. This may affect your ability to qualify for financing if you’re going to buy another property.

  • Make sure the sales contract is conditioned on the lender giving any necessary consent and agreeing to release you if the buyer qualifies to assume the loan. If the buyer can’t qualify, you should reserve the right to terminate the contract.

  • Consider what type of interest rate and payment schedule is appropriate. You may allow payments of interest only for a stipulated period (with a balloon payment at the end), or you may wish to amortize payments so that the buyer is paying down some principal each month. The latter is the better option if the buyer can afford it.

The sales contract should specify the exact payment terms and include some detail regarding other terms of the note and mortgage you’re taking back. It should also require the buyer to pay recording fees and taxes on the mortgage, as well as the premium for a mortgagee title insurance policy.

The mortgage itself should provide that any default by the buyer under the first mortgage will also be a default under your mortgage. It should give you the right to cure those defaults to protect your interest in the property, with any expenses you incur being added to the amount you’re owed.

The mortgage should also require you to be named as a beneficiary of the buyer’s casualty insurance policy, and it would be a good idea to require liability insurance as well. It should have a due on sale clause, as well as a clause prohibiting any other mortgages; otherwise, the buyer may sell the property to someone else who won’t keep up your payments, or the buyer may pull their equity out of the property by getting another mortgage.

Most real estate brokers and office supply stores don’t have comprehensive forms of purchase money notes and mortgages available. Since you may be financing a significant portion of your equity, you should have a lawyer help you draft the sales contract, as well as the purchase money note and mortgage, to address these concerns. Once you’ve signed the contract, it may be too late.

This article is informational only. You should consult an attorney before acting or failing to act. The law may change rapidly and no warranty is given. LOWNDES DISCLAIMS ALL IMPLIED WARRANTIES AND WITHOUT LIMITATION, ANY WARRANTY OF FITNESS FOR A PARTICULAR PURPOSE. ALL ARTICLES ARE PROVIDED AS IS AND WITH ALL FAULTS. Consult a Lowndes attorney if you wish to establish an attorney/client relationship.

With more than 30 years of experience in real estate law, including over 20 years as a Board-certified expert in the field, Gary Kaleita has acquired the ability to navigate the complexities of sophisticated real estate deals with relative ease.

Gary has a wide variety of experience in real estate development, finance and transactions, condominiums, property owners’ associations, commercial leasing, commercial lending, and title insurance.

Gary enjoys a reputation for anticipating and avoiding problems, rather than merely reacting to them. He has years of experience handling purchases, sales and financings of commercial and residential projects, including office, industrial, retail, multi-family, single-family, condominium, resort, hotel and golf course properties. Gary has prepared and negotiated contracts for sale and purchase, performed due diligence investigations, and handled all aspects of closings, including issuance of title insurance and legal opinions. He has also performed tax free exchanges (both forward and reverse) under Section 1031 of the Internal Revenue Code, and has handled closings for housing revenue bond financing transactions with the Florida Housing Finance Corporation and various local housing finance authorities.

In the area of real estate development, Gary has assisted developers in obtaining land use approvals, plat approvals and permits for various developments from a number of jurisdictions in Central Florida, including planned developments (PD’s) and Developments of Regional Impact (DRI’s). He has drafted and negotiated complex land use documents, including development agreements, cost-sharing agreements, declarations of covenants, conditions, restrictions and easements. He also has experience in mall and shopping center developments, including outparcels, and has assisted developers with the selection, formation and operation of business entities, including commercial and residential property owners associations. He has extensive experience with the formation and operation of both commercial and residential condominiums as well.

In addition, Gary has established somewhat of a boutique practice by acting as local counsel to help out-of-state lenders, investors and law firms navigate the complexities of Florida real estate law. He is frequently engaged by large national and international law firms needing assistance on a variety of issues for their clients doing business in Florida. Gary regularly provides advice on Florida law and custom pertaining to purchase and sale contracts as well as loan documents, addresses local due diligence issues, answers questions involving titles, surveys and title insurance, and provides Florida legal opinions.

Not just another real estate lawyer, before pursuing his career in law Gary served as a U.S. Naval officer on active duty for 4 years in the Mediterranean Sea, first with a patrol gunboat squadron in Italy and then at a communications station in Greece. During this period he traveled extensively throughout Europe, the Middle East and North Africa. He believes his military experience is the source of the practical approach he has developed to problem solving.

Gary also took the initiative, after a homeowner in his own neighborhood was mauled by a Florida black bear in 2013, of researching what his homeowners’ association could do to limit the likelihood of future attacks. In the process, he became an expert in the subject of “bear-wise” communities and drafted a policy that his own homeowners’ association adopted, thereby becoming the first residential community to be officially recognized as bear-wise by the Florida Fish and Wildlife Conservation Commission (FWC). He has since written and spoken extensively on this subject, serves on the FWC’s Central Bear Management Unit Stakeholder Group, and has become a resource for FWC to educate other communities on the importance of bear-wise practices in areas of Florida containing black bear habitat.

Gary focuses on finding pragmatic solutions to complex problems, recognizing that clients want sensible and realistic advice in a timely manner so they can go about their business.

Chambers USA (2015)* reports that Gary has substantial experience acting as lender’s counsel and is acclaimed by market sources as an “extremely responsive, very practical and reasonable” practitioner.

*We make no guarantees or promises that the reader will realize the same or similar results

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