Q: I am thinking of providing owner financing to a potential buyer of one of my homes. This would be a second home for my buyer and he would use it as his vacation home. What would happen to that second home if he were to declare bankruptcy or if he loses his primary residence in a foreclosure?

A: We think you’re asking the wrong question. The real question you should ask is this: What will happen to the property you sell this person should he stop making his payments to you?

If you provide financing to this buyer, will he put down a substantial down payment? If he does, a large down payment should give you some comfort. If he puts down little or no money, you might be better off renting the home to him, and perhaps arrange to sell it to him in the future when his finances are more stable. Evicting a tenant from a lease is easier in most states than going through a foreclosure.

If you sell the home to him and he has financial difficulties with his primary residence, his financial difficulties most likely would spill over onto the vacation home. Homeowners are likely to stop paying the mortgage on a second home before putting their primary residence in jeopardy.

In a bankruptcy, you might find that you still have to foreclose against this buyer if he stopped paying on the loan you gave him for the purchase of the property.

If you suspect that your buyer is in financial stress, why would you want to sell him your home? If he merely loses his primary residence in a foreclosure, that fact alone should not affect his ownership of the vacation home. The key is whether he pays you the money he owes and whether you have enough of a cushion in the transaction to weather the storm should he stop making his payments to you.

Before you proceed with the sale of the home to this buyer, make sure you have obtained a copy of his credit report and understand his financial situation. Once you do, make sure you hire an attorney to advise you on structuring the sale to this buyer.

One option might be to sell it to him and take back a mortgage. But another option might be to sell him the home by using an installment contract for deed, otherwise known as a sale of the property over time where you retain legal title to the home.

Another issue you might face is whether you currently have a loan on this property and whether you intend to pay off this loan.

If you’re financing your buyer’s purchase of the property, but you still have an existing loan that you’re not planning to pay off, this could cause a huge problem for you down the line.

Aside from running afoul of your current lender’s requirements, you’ll have lost control over the asset. If the buyer fails to make any payments that are due, you’ll have to continue to make the payments to your lender. If you don’t, you’ll harm your credit and your lender could foreclose on the home you sold to this person.

For more details about how to protect yourself, please talk to a local real estate attorney.

April 9, 2009

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