When you buy a seller-financed note, do you really know what obligations you can enforce? You know that if the note is secured by real estate and the payor fails to pay, you can take the property back through foreclosure.
But what if the property has lost its value? What if the local economy has collapsed? What if the property has been damaged or destroyed? Are you stuck with a big loss? Maybe not. In most states and most situations, note buyers have the law on their side to take further steps.
When the property is worth less than the note
Every state allows you to foreclose and take the property back. In many cases you will be able to resell it for as much as, or more than, you expected to gain from the note. That requires the property to keep its value, though. What if the value falls?
Now you have a deficiency: the gap between what you were owed and what you actually received. Many states let you enforce the promise in the note. That means you can demand and receive the full amount owing on the note.
Can you actually collect it?
The payor may not realize this and may refuse to pay, saying that all you can do is take the property back.
If the payor has no other assets that could be applied to the deficiency, the payor may be right in practice. Legally you have an enforceable promise. In practical terms, you would be wasting your time, money and effort trying to collect. As the old saying goes, “You can’t squeeze blood out of a turnip.”
If the payor owns other assets that can be attached, however, you may be delighted to collect all the money the payor owes you. Since you usually have no financial information on the payor, and no right to obtain it, your first step is to tell the payor that you intend to seek full payment on the note. If the payor has assets to protect, they will normally pay once they understand their personal liability.
Watch out for the deed in lieu of foreclosure
If you are facing a deficiency, stay on guard and keep your presence of mind. Most payors will act honorably and pay everything they owe. But you need to know about one strategy that can be used to avoid paying a deficiency.
The payor may offer to give the property back to you through a “deed in lieu of foreclosure.” This is a common, fast and inexpensive way to return a property when the payor falls into financial trouble. If the property has kept its value, it could be the best choice.
If the property has lost value and there is a deficiency, though, accepting it can be a bad move. Once you accept the deed in lieu of foreclosure, the property is yours, and you may have given up your legal right to collect any more money from the payor. A smart payor may count on your not knowing this and offer the easy way out. You may be so eager to solve the problem that you forget to ask your attorney about collecting the deficiency.
Talk to an attorney before you buy and after a default
Note buyers should consult an attorney before buying any seller-financed note, and again if the payor defaults. If the attorney tells you that you have the right to collect a deficiency from the payor, you may see a ray of sunshine. Ask the right questions and you’ll get the right answers.
