A subordination clause in a mortgage is a very common scam

Are there scams a seller financing the purchase price should be aware of?

There is a common scam in these transactions - a subordination clause in the mortgage. This clause states that the buyer can borrow money after your mortgage is recorded and gives the new lender a mortgage superior to yours. In these clauses, you agree to subordinate your mortgage to this later loan. In other words, your first mortgage will become a second mortgage or your second mortgage will become a third mortgage. Since higher mortgages wipe out lower (junior) mortgages, you can see the danger.

I call the subordination clause a scam. It is considered a strategy by some. Seminars on how to buy property with no money sometimes teach the subordination clause as a legitimate purchase method. This is why it is so commonly used. If you are asked by a prospective buyer to insert a subordination clause into the purchase money mortgage, you can be fairly sure that this buyer intends to borrow the full value of the property with a mortgage or mortgages superior to yours. After you subordinate, you will be left with worthless paper unless the property greatly increases in value.

Subordination clauses are also used when construction is involved. This is an entirely different situation; subordinating to a construction loan may be desirable for a seller of empty land to a developer. It is not a good idea for a seller of an existing home.

Can I sell the purchase money mortgage?

If you do decide to take back paper, you can keep the mortgage or sell it. The secondary market works for individuals, too. The difference is that you will not be selling yours to Fannie Mae. You will sell to a company or individual investor that buys purchase money mortgages. The smart thing to do is investigate the market before agreeing to take the mortgage. Your real estate agent should have a contact that invests in these mortgages. You can find investors in the newspaper or on the Internet, but a personal recommendation is usually better.

By doing this, you can get an idea of the discount you will have to give. The amount will depend on many factors, including rising or falling home prices. Do not expect the one or two points that apply to institutional lenders. You could have to discount your second mortgage by 50% or more. If you have the first mortgage for the majority of the purchase price, to sell it could require a 10%–30% discount. Again, there are many factors involved and you may have to give a much lower discount.

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