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"invest in your own debt. Payoff any existing credit card debt, mortgages, etc. that carry interest rates higher than that which can be earned with absolute safety any other place."

Regards,
FMO
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Hijacking a thought: FMO's comment reminded me of something that we have been considering of late... carrying back the paper when we sell our current residence...

The $500,000 forgiveness of gain for couples filing jointly will just cover, with a little margin, our gain, so I don't believe we will owe a tax on the profit were we simply to sell for cash. But:

My question is: Has anyone else carried back the paper when selling their residence? Do's and don'ts? Really big regrets? Etc? I assume we'd have a 'regular' collector receiving payments, sending out late notices if needed, etc... and getting a piece of the action for their trouble... I would guess we'd receive ~~5.5% right now, which is quite above anything out there that is really safe...

And we could always make it a 30 year due in 7, or some such, "just in case we want it all sooner, etc"....

I 'know' we'll have a slightly more involved return to file each year as we receive Installment Payments, as defined in IRS Topic 705. Etc.

Thanks. BB.
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I have done so in the past; however, I think you are confusing two issues: (1) making a mortgage on property you just happened to have sold; versus (2) an installment sale of property. If you carry back the paper you are just writing a mortgage; it is not an installment sale; therefore you own an asset --- the mortgage and each month you receive payment which is mostly interest and some principal. You would report the interest only as earned interest on Schedule B of your 1040.

Further, I see no need for an intermediary. It's not real difficult to prepare and send a mortgage notice each month; collect late fees if necessary and send out a 1098 statment once a year.

TheBadger
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BrerBear writes:

My question is: Has anyone else carried back the paper when selling their residence? Do's and don'ts? Really big regrets? Etc?

Carrying the financing is an important option to consider and can be a great idea for the right person under the right circumstances. It can also be a disaster. In most cases, I would recommend that your buyer has substantial equity in the deal to provide incentive not to default. I would also keep the financing short; i.e. due in 5 to 10 years. Whoever you finance should be qualified and determined to be an excellent credit risk. The papers should be drawn by an attorney to make sure you enjoy the benefits of all lender protections allowed in your state. Installment sales make more sense to me as a means of tax deferral and less sense on the sale of a personal residence.

The primary advantage is that you may be able to sell for a higher price by providing built-in owner financing. It is also nice to receive a stream of payments secured by valuable real estate.

Things to watch out for: A mortgage note is like a long-term callable bond. You are locked into the rate stated in the mortgage for the entire term. If interest rates go up, you are stuck with an under-performing asset. The borrower however, can refinance or pay off the note whenever he wants. This could result in you receiving a lump sum at an inopportune time to reinvest. If the borrower's equity is thin and he runs into financial difficulties (particularly in a bad real estate market) you could end up with the property back (also at an inopportune time). You could even find yourself under-collateralized with no way to completely recover. If the borrower declares bankruptcy, you may lose access to the payments as well as the principal for an extended period.

To summarize:

Qualify your borrower.
Require that your borrower have a substantial equity stake.
Keep it short.


Regards,
FMO
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We've carried paper in the past without problem, but I've always used an intermediary. I don't want someone calling me and telling me they can't quite make the payment this month, and foreclosing is something you really want to avoid. It's not nearly as easy as some on these boards would lead you to believe. The borrow has lots of legal rights and can trash the place if there is a dispute. Be careful.

db
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"The borrow has lots of legal rights and can trash the place if there is a dispute. Be careful."

Hi db,

Yup. My ex and her husband got to rehab their property after it had been used as a meth lab :-( You better have the right temperament to deal with any possible happenings. For me I would not carry any paper unless it was the only way to sell and then it would be a second and no more than 10% or so...

To each his own,

Regards, Ken
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I assume we'd have a 'regular' collector receiving payments, sending out late notices if needed, etc... and getting a piece of the action for their trouble... I would guess we'd receive ~~5.5% right now, which is quite above anything out there that is really safe...

If you don't have the experience and temperment which would allow you to act as collector yourself, this is probably a bad idea. I think that the cost of hiring a "regular" collector would substantially reduce the return you would get. Probably putting it in the same range as a T-bill.

Not a criticism, just an observation.

The other thing to think about is could your wife do the collecting if you were not available for any reason? How about your heirs?

I have years of experience in collecting rents and would have no problem collecting a mortgage myself, and my wife could do the same. Maybe our kids could do it in 15 years, but they are not ready now.

If you decide to do it, don't forget to put in a clause with a really draconian late fee--the highest the law will allow. If your buyer balks at this be prepared to look him straight in the eye and say: "You aren't planning to be late on any of these payments are you?" If he isn't, the size of the late fee should not matter to him.
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BB,

Make sure that you understand the tax rules. It could be that with the $500K exemption you dilute the effect if you use an installment sale (carry back paper).

Second, there is no reason not to keep the same idea but secure the paper by other properties. This is mostly to address an issue that someone else pointed out which is you can get paid off when you do not need a lump sum. You are left trying to figure out what you would do with the lump sum. If you are open to paper on a different home then you just re-invest.

Third, the interest rate you are assuming is low by private mortgage standards. I created just under $1M in new 1st notes in Q1 2005 averaging 15%. All were 65% LTV or less so very secure when it comes to the other party having a stake in the property. All were with investors who expect to pay the low off after them make improvements or otherwise change the dynamics of the deal.

Fourth, there is a loan servicing agent (LSA) who collects the checks, mails the notices and otherwise handles the paperwork. They charge $25 to set up the account and $10 per month to service the loan. Hence the fees are not proportional to the loan size. It impacts the yield but you are still certainly doing a lot better then T-Bills as someone else implied.

John B. Corey Jr.
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