In a seller carry-back financing situation, the seller shifts roles immediately upon the close of escrow. Before escrow closes, the seller is focused on ensuring the property ownership is transferred smoothly from themself to the buyer. But once escrow closes and title transfers, the seller immediately transforms into a lender. The relationship between seller and buyer quickly alters to one of lender and borrower. Why would anyone agree to this? Seller carry-back financing can benefit both parties, but for any seller willing to assist the buyer with financing, it is a perfect way to increase the return from the sale of the property.
When a seller is motivated to sell, and a buyer is determined to buy, they are often willing to consider unconventional means of closing the deal. For that reason, seller carry-back financing is more common than most people think. Even so, more often than not, the seller does not purchase a lender’s policy of title insurance. Why? Many times, the seller has no concept what it means to be a lender or what safeguards exist—specifically, title insurance—to protect them if the loan goes south.
Any prudent seller who is willing to become a lender needs to take, and be aware of, every precaution an institutional lender would take, and this includes exit strategies. It is incumbent upon their agent and/or broker to guide them through that process and explain the protections afforded by a lender’s policy of title insurance.
Many sellers may not know that becoming a lender means they retain a record title interest in the property, and that interest will either be senior or junior to any other liens or encumbrances affecting the property. No matter the lien position the seller carry-back lender obtains, that position needs to be protected. A lender’s policy protects the lender from subsequently discovered liens and/or encumbrances that affect the lender’s lien position and/or impair its security interest.
Every institutional lender purchases a lender’s policy for the same reason: recordation of the Deed of Trust is simply not enough. Why not? What could possibly go wrong? If a lien was recorded years earlier, but improperly indexed by the County Recorder’s office, you would not be aware of the lien when your deed of trust is recorded. The result: while you thought you were in second position, now it turns out you are actually in third position and there is no equity to protect your interest in the property. Without title insurance, there is nothing you can do about this sudden blow to the interest you previously thought was fully protected by a recorded deed of trust. In that brief second that you learned of the pre-existing lien, your security interest is fundamentally destroyed. This same result arises from the discovery of any easements, boundary line issues, judgment liens, forged instruments, unrecorded interests, tax defaults, etc. All of these scenarios can affect the rights of a lender, and there are far too many issues that can arise and destroy the lender’s ability to profit from its decision to finance the deal—but even worse, it may cause the lender to lose its collateral altogether.
Sophisticated lenders know of all the pitfalls that can arise, but does your seller know that the recordation of a lien against the buyer before the transaction closes may jeopardize their loan security? If your seller is considering stepping into the world of seller carry-back financing, they need to be fully educated on all the benefits, and more importantly, all the essential protections, of lender’s title insurance. A seller/lender not willing to purchase title insurance has no business stepping into the shoes of a lender and should certainly be dissuaded from doing so.
