A Guide to Seller Carry Second Mortgages

Many real estate investors know the power of seller carry second mortgages. Most home buyers, however, don’t know this method of financing.

Used at the right time and in the right way, a seller carry second mortgage can sweeten the deal for home buyers and sellers alike.

What Is a Seller Carry Second Mortgage?

A seller carry second mortgage combines traditional mortgage financing with seller financing. The mortgage lender finances most of the home, but the seller finances part of the home, too. Compared to full owner financing, a seller carry second mortgage can be safer for both the buyer and the seller.

With ordinary seller financing (a.k.a seller carry back), the home’s seller finances the entire purchase price of the home, minus the down payment. The seller doubles as the mortgage lender, accepting the risk that the buyer might not repay or refinance the loan as agreed. The owner receives payment gradually rather than accepting a lump sum of cash in exchange for the home.

Meanwhile, the buyer takes some risks, too: In most cases, the buyer will pay a higher mortgage rate, and the buyer can’t rely on consumer protections that federal law requires lenders to provide.

How seller carry second mortgages are different 

Seller carry second mortgages are different in several ways:

• First, the buyer uses a traditional mortgage loan from a lender to cover most of the home’s purchase price.
• Then, the home’s owner finances a smaller slice of the home’s price.
• Finally, along with making payments to the lender for the primary mortgage, the buyer makes smaller payments to the owner to service the second mortgage.

As a result, the seller will not have to wait to receive most of the home’s purchase price — and the buyer has an agreement with a mortgage company for the primary home financing.

How can a seller carry second mortgage benefit buyers?

A seller carry second mortgage takes some of the pressure off the home buyer to fully finance the home with a lender. Relying less on the first mortgage lender can be a deal maker when:

• Interest rates are higher: Higher interest rates create higher monthly payments for the same size loan. When the seller finances part of the purchase, the buyer can pursue a smaller first mortgage. Plus, lenders could offer a lower interest rate since they’re financing a smaller slice of the home’s value.
• The buyer faces credit challenges: Along with paying higher mortgage rates, buyers with average credit tend to qualify for smaller mortgage loans. A seller carry second mortgage could close the gap if a borrower can’t qualify for a primary mortgage that’s large enough.
• The buyer documents a lower income: Loan sizes also depend on the borrower’s documented monthly income. Again, the second mortgage financed by the seller can help close the gap if the buyer’s paystubs won’t support the full loan amount.

Essentially, a seller carry second mortgage boosts the buyer’s borrowing power. This boost could push the buyer over the top and make buying the home possible. 

What are the risks to the buyer?

A seller carry second mortgage won’t be a slam dunk for every buyer. Risks include:

• The seller’s lien: The seller will retain a lien on the home. This means the owner could repossess the home if the buyer doesn’t pay as agreed.
• The first lender’s approval: Not every mortgage lender will accommodate owner financing as part of the financing arrangement. Buyers should run the idea by their primary lender as soon as possible.
• The seller’s word: Mortgage lenders have to follow federal laws that protect borrowers; sellers don’t have to follow these financing rules. This could create more risks for buyers. For example, the seller may penalize the buyer for paying off the loan early. Buyers should get legal advice if they’re concerned about the financing agreement.
• The home itself: Seller carry second mortgages are not common with residential properties. They are much more prevalent for commercial properties like 5+ unit apartment buildings. If the seller is offering to finance part of the purchase, especially in a seller’s market, buyers should find out why the home needs special financing to sell.

Unlike traditional mortgage financing — in which the relationship between the buyer and seller usually ends on closing day — seller carry second loans extend this connection between the buyer and the seller. 

Before inking the deal, buyers should ask themselves: Do I want to be in a financial relationship with this seller for years into the future? 

How can seller carry second mortgages benefit the seller?

Carrying a second mortgage for the buyer helps sellers when:

• Credit markets are tighter: Higher mortgage rates create higher payments, making homes less affordable for buyers. Offering to help with financing could entice more buyers into making offers.
• It’s a buyer’s market: Offering to finance part of the home could give sellers an edge over other sellers during a buyer’s market.
• They want to earn income from interest: Like a traditional lender, a homeowner who finances part of a real estate purchase can earn income from interest.

What are the risks to the seller?

By its nature, financing is risky. Sellers who carry a second mortgage for a buyer risk:

• Having to foreclose: If the buyer won’t or can’t repay the second loan, the owner may have no choice but to begin foreclosure proceedings, which require time and money. 
• The primary lender foreclosing: If the buyer defaults on the first mortgage, the primary lender could foreclose. The seller may feel like a bystander in the foreclosure proceedings — a bystander who isn’t guaranteed to recoup losses.
• Not earning as much interest: If the buyer pays off the second loan sooner than expected, the seller may not earn as much interest income after all.

Sellers who agree to finance part of the home for the buyer should protect themselves. They should insist on holding a lien and being registered as a lienholder with the buyer’s home insurance company. Ask an attorney to look over the financing agreements before signing them. 

When is a seller carry second mortgage better than traditional financing?

Seller carry second loans work best as temporary home financing. While most primary mortgages carry terms of 30 years, most second mortgages have shorter terms — five to 10 years.

Plus, sellers often structure second loans to require a balloon payment. This means the buyer would owe a large sum of money at the end of the second loan’s term, usually in five to 10 years.

Because of this, many buyers will need to refinance the home — or at least refinance the second mortgage — within five to 10 years of taking out the loan.

At their best, seller carry second mortgages buy time while the buyer arranges more permanent financing or sells another property to pay off the second loan’s balance.

Seller carry second mortgage scenarios 

Let’s take a close look at how this could play out in real life. We’ll say you’re buying a $400,000 home but can get approved for only $300,000 from a traditional lender. The seller is willing to finance part of the remaining $100,000.

Your primary lender won’t allow the seller to finance the entire $100,000. This would mean you have no skin in the game, and lenders know people who don’t invest any of their own money into a home are more likely to walk away from a loan.

The first lender will let the owner finance $60,000 of the remaining $100,000. You’re covering the other $40,000 from savings. 

30-year mortgage for $300,000

You’ve been approved for a 30-year mortgage with a fixed rate of seven percent to cover the $300,000. This loan will require:

Principal and interest	$1,996 a month
Property taxes	$200 a month
Homeowners insurance	$200 a month
Private mortgage insurance (PMI)	$200 a month
Total:	$2,596 a month

*PMI, Homeowners insurance and property tax rates vary by location and borrower.

$60,000 seller carry second mortgage

For the $60,000 second mortgage, the owner has agreed to a seven-year term with a balloon payment at the end. The seller is charging nine percent interest because of the higher risk. 

Principal and interest	$483 a month
Property taxes	N/A
Homeowners insurance	N/A
Private mortgage insurance (PMI)	N/A
Total:	$483 a month

An extra $483 a month looks pretty reasonable, but at the end of the seven-year term, the buyer will owe a balloon payment of $56,667 — almost as much as the $60,000 borrowed. 

Why so high? Because the monthly payments during the seven-year term cover mostly interest.

Who would do this?

This scenario makes most sense for a homebuyer who already plans to refinance or sell the home before the second loan’s balloon payment comes due. 

Let’s say the home appreciates in value by 3 percent a year:

Length of ownership	Home value*
At time of purchase	$400,000
After year 1	$412,000
After year 2	$424,360
After year 3	$437,091
After year 4	$450,204

* Actual home appreciation varies by market and location.

In this example, the $400,000 home has gained about $50,000 in value over the first four years, making it worth $450,204. 

The primary mortgage balance is down to $287,000. The second mortgage financed by the seller has a balance of $58,115. That totals $345,115 in mortgage debt on a home valued at $450,204.

Let’s do the math: $450,204 in home value minus $345,115 in mortgage debt. That equals about $105,000 in home equity — more than enough to qualify for a competitive refinance rate. Refinancing would pay off the second loan, ending the relationship with the seller.  

It was a roundabout path, but this buyer managed to get into a good position on a $450,000 home despite getting approved for only $300,000 four years earlier. 

A not-as-good outcome

Everything went well in the scenario above. The home appreciated, the buyer kept up the payments, and the buyer avoided the punitive balloon payment that would have been looming at the end of the seven-year second mortgage.

But even our best-made plans fail sometimes. For example, let’s say the housing market in your town stagnated and your home appreciated by only 1 percent a year. After four years, the $400,000 home would be worth $416,200 — not $450,204. 

Yet the combined mortgage debt on the home would remain the same: $345,115. In this scenario, you’d have only $71,085 in equity. It’s still possible to refinance with this level of equity, but the loan-to-value ratio (LTV) would be higher — all because of a variable the buyer couldn’t control: the home appreciation level.

A worse outcome

It’s possible for homes to stay the same or even to lose value, at least temporarily. Home prices lost tremendous value in many markets after the housing collapsed in 2008. In most areas, values had recovered, and then some, by the early 2020s. Still, that was no consolation to someone who was upside down on a home they needed to refinance in 2012. 

If a similar instance of bad timing struck, and your $400,000 home was worth only $390,000 four years later — and you still owed $345,115 in mortgage debt — you’d have about $45,000 in equity. This could be cutting it close for a refinance. 

In this case you may want to wait another year or two for house prices to recover. In this case, you’d be running up closer to the balloon payment’s due date on the second mortgage. Or, you may be able to refinance only the second mortgage and not the entire mortgage debt.

Buyers should control what they can control 

Nobody can know, with certainty, which way home values and interest rates will go in the future. For instance, in 2019, many economists expected mortgage rates to rise in 2020 and 2021. They didn’t foresee the global pandemic that drove mortgage rates to their lowest point ever.

Because of this, buyers should never create scenarios that depend on home appreciation or low mortgage rates in the years ahead. Instead, they should try to position themselves for any future market. Do this by: 

• Not overspending: Borrow only what you need, even if the owner-financer can lend more. 
• Negotiating with the owner: Would the owner finance at a lower interest rate on the second mortgage in exchange for the buyer taking care of some of the repairs — or in exchange for the buyer paying all closing costs? If so, this could pay off.  
• Preparing for the eventual refinance: You know you’ll be refinancing the seller carry loan, and maybe the entire mortgage, in a few years. So start getting ready. Keep your credit in good shape and try to make some principal payments on the primary mortgage.

By preparing for an average or poor market, buyers might be in fantastic shape if the market turns out to be more favorable later.    

Alternatives to seller carry second mortgages 

Residential home buyers who need help from a seller carry second mortgage could find help from a different source instead:

• Down payment assistance: Some cash-strapped buyers can get help through local down payment and closing cost assistance programs — or from family members. Programs vary by location; some operate as silent second mortgages. Sometimes these second loans are forgiveable when buyers stay in the home long enough.
• A cheaper home: Could you buy a home priced within the range your primary lender will approve? In some markets this isn’t possible. But some buyers can find less expensive homes that still work.
• A different loan type: FHA loans are designed to help buyers with average credit scores. You may qualify for a larger loan amount through the FHA, eliminating the need for a seller carry second loan. Military veterans should always check out the VA loan program. USDA loans help rural buyers get loans with no money down, saving cash

Before entering any kind of alternative financing arrangements to buy a primary residence, it’s best to exhaust other traditional financing plans. 

Ready to refinance a seller carry second mortgage? 

For many buyers, accepting a seller carry second mortgage starts a countdown to an eventual refinance.

When it’s time for the refi, you can find the best rates and fees by shopping around with several different lenders. 

See today’s rates here.