There’s no question the decision to offer seller financing involves an amount of risk. A buyer wouldn’t be seeking seller financing if their financial situation allowed them to secure a traditional bank loan.
That’s why sellers should secure a large down payment on a loan. In addition, they should set an interest rate that’s higher than what banks can offer. The higher down payment means a buyer has more skin in the game. Making defaults less likely. The higher interest rate is the price a buyer pays for their less than stellar credit position.
Unfortunately, even when a seller makes every effort to mitigate risk, a buyer may still end up defaulting on their loan.
If this happens, you may wonder what the next step is when a buyer defaults? What is your recourse? And how should you proceed?
How Late is Late?
Whatever the due date on a mortgage, borrowers are commonly given a 15-day grace period before any late-payment penalties are imposed by the lender. In traditional lending, a lender must wait until a borrower is more than 30 days late on a payment before they can report a delinquency on the borrower’s credit report. Therefore, a seller-financed mortgage isn’t officially considered delinquent until 30 days have passed without payment.
Any delinquency should be concerning to you since it represents a delay in receiving your investment return. It’s up to you whether you want to give your borrower the benefit of the doubt. If it’s a single payment that’s a few days late, especially if they have a proven history of paying on time, there may be a viable explanation. It’s certainly possible that a processing issue occurred.
Keep an eye out, though, for a payment that’s still missing after the 15th day or a sudden cancellation of automatic bank payments. These could indicate a more serious problem.
What are Your Options if Your Buyer Defaults?
If you have not received the borrower’s payment within the grace period allowed on their note, it’s time for you to act.
In addition to this being an indicator that your borrower may be having difficulty meeting their obligation, it also changes your note status from performing to sub-performing. If you wanted to sell the note and walk away with cash in hand, the note is now worth less.
At the very least, you should send the borrower a late notice outlining the late fees due. These late fees must be in accordance with the provisions outlined on the original mortgage note. They cannot exceed the amount allowable by the statues of the state where the deed is recorded.
As a side note: If the borrower eventually makes the monthly payment but refuses to pay the late fees, they are still legally liable for the fees, but you have limited recourse to collect them. They cannot be used as justification to initiate foreclosure proceedings and they cannot be used as justification to reject a regular principal and interest payment. Your best option is to include the late fees in your regular accounting of the loan, and attempt to collect payment at final payoff.
When Your Borrower is More than 30 Days Late
Once your borrower is officially more than 30 days late on their payment, it’s time to decide how you want to proceed. If you have a personal relationship with the borrower (perhaps the borrower is a family member) you may want to work with them directly to resolve the late payment.
In most cases, though, it may be time to either move forward. This can be done with legal action or by considering selling your note. Or perhaps you walk away all together.
Selling Your Note
If you believe your borrower is likely to remain in default, you have options besides legal proceedings. You might consider selling your note for a lump sum of cash.
While the value of the note will decrease somewhat due to the delinquency status. However, you will be able to walk away free and clear. Without the hassle of a potential foreclosure process. This is especially important if you don’t live near the property. You may find yourself traveling extensively to deal with the legal proceedings associated with a foreclosure.
Deed in Lieu
You may consider obtaining a deed in lieu of foreclosure from your borrower. With a deed in lieu, your borrower transfers the title of the loan back to you. Opposite of that, you release them from all obligations relating to the remaining balance. You are then free to re-sell the home.
A third option is to pursue a foreclosure proceeding. It’s important to proceed very carefully from this point. It’s important to ensure you’re fully and accurately complying with federal and state laws. If you don’t, you may find yourself having to start the process over from the beginning. Losing valuable time and money.
Because the laws vary from state-to-state. It’s important to understand the appropriate process for the state in which the property is located.
Generally, the foreclosure process includes multiple steps of notifying the borrower. Including, filing a notice of delinquency and a notice of default with the court in the county where the property is located.
Once the foreclosure is complete, you may have to contend with repairs to the property so that it is in sellable condition. If you did not arrange loan payments to include escrows for taxes and insurance, you may also find that you’ll have to pay any delinquencies owed.
You may find it helpful to consult with an attorney if you’re facing a borrower default situation on the seller-financed mortgage you’ve provided. This way you can ensure you’re following all appropriate laws. If you’d like to discuss selling your note as an option, please contact us here, and we’ll be happy to talk with you about your note.