For newer brokers who don’t know what a holdback is, and for those who know and don’t like it, here is some food for thought from the funder’s side of the table.
What a holdback is and why funders take one
A holdback is one or more payments deducted, or “held back,” from the broker’s or seller’s proceeds at closing.
When a funder buys a note, the payor hasn’t yet been told to send payments to the new owner. So the next payment will likely go to the seller. That is where the holdback comes in.
Many sellers cash the payor’s check and let the funder call the payor to collect what looks like a late payment. Without a holdback, that would start a potentially difficult process of collecting from the seller. With one, when the payor says the seller received the payment, the funder simply confirms it with the seller and applies the holdback to the payor’s account.
If the payor gets the funder’s letter of introduction in time to send the payment directly to the new owner, the holdback is refunded right away to the seller or broker, whichever paid it.
Who pays the holdback: seller or broker
It is in your best interest to negotiate the holdback as a deduction from the seller’s proceeds whenever possible. It keeps the transaction simple for you. On the rare occasion that the seller refuses, the holdback comes out of your commission.
The risk is that the seller knows something the funder doesn’t. If the payor isn’t performing, the seller can’t count on getting the holdback back. A seller’s reluctance is some cause for concern, though it doesn’t necessarily stop the purchase.
If you take the holdback out of your commission, you may lose it. If the payor then sends the payment to the seller, you, the broker, will have to collect it from the seller. The funder won’t collect on your behalf.
The 90-day first-payment rule
Be aware that you may be out the amount of the payment if it isn’t received within 90 days of closing. After 90 days, first-payment default occurs, and the holdback is forfeited to the funder to help cover the cost of collection, up to and including foreclosure and repossession. One holdback won’t cover all of those costs, but it helps.
How to raise the holdback with the seller
You can help the purchase along by discussing the holdback with the seller up front, at the same time you decide who will pay closing costs. That way it doesn’t come as a surprise at the end and hurt the deal.
Be diplomatic. Avoid the subject of delinquency, a hot topic that may offend the seller. Instead, focus on the logical question: where will the payor most likely send the first payment?
