Risks and Rewards of Owner-Carry Contracts

When selling personal property like vehicles or real estate or business interests, owner-carry contracts will often come into the picture. An owner-carry contract (OCC) is a private contract between the buyer and seller setting out the terms of the arrangement. Typically, a financial institution or title company is not involved in the property transfer and in monitoring the payments, etc.

You might be friends, but money can change things...

OCCs can be a powerful tool, but the risks and rewards of entering into one are substantially different depending on which side of the transaction you are positioned.

Buyers typically favor an OCC for the following reasons:

1.      No credit check is involved, and financing can be obtained without the onerous financial institution underwriting process;

2.      There is no impact to credit reports in terms of missed payments or debt to income ratios (meaning that either non-existent credit may be used or credit may be reserved for some other use);

3.      Often broker fees can be avoided as well as closing costs including title insurance, escrow and other transfer fees; and

4.      Terms that would not be acceptable to a financial institution can be negotiated such as longer length loans, lower interest, lower down payment, and less burdensome reporting or legal requirements.

You don't know what's on the balance sheet, really, until you get their actual financials.

Sellers might accept an OCC from a known individual or entity and might be tempted by the possibility of collecting the principal and the interest. Additionally, an OCC extending beyond three years might help with capital gains taxes, but some of the benefits outlined above are also the very reasons that OCCs are so risky for them. So, while avoiding closing costs or broker fees might be attractive, the following risks require careful consideration:

1.      The inability to properly assess creditworthiness is a substantial issue;

2.      The fact that the Seller would not be able to report payments to a credit bureau allows a Buyer to potentially overextend their credit since the OCC doesn’t show;

3.      The lack of a rigorous underwriting process may allow an unprincipled Buyer to not disclose critical information that could later lead to default on the loan; and

4.      Most Sellers are underequipped to enforce their OCC and may not have gotten the legal protections necessary to do so in the first place.

Balancing risk is what banks do, and as it just so happens, so should you!

In conclusion, OCCs may work for your particular situation…but it is essential to understand the risks. Many uncertainties may be avoided by engaging a professional to gauge the merits of the offered deal. A key consideration is to avoid “giving away the farm” by accepting terms that favor the Buyer when all the negotiating power is vested with the Seller. For instance, it would be unwise to extend an OCC to a Buyer with limited down payment or who wants reduced interest or an unusually long term. Be aware that commercial loans generally require higher interest, shorter terms and very strict underwriting because the risk is much, much higher. Make yourself aware and be on your guard against granting more than a financial institution would generally allow…and get the paperwork done correctly.

Curry Andrews, Attorney