An owner of investment property free of a mortgage who desires to sell may face the dilemma of whether to receive payment in full at closing or to hold a mortgage so that payments are received over time (with interest).  This is what is commonly referred to as seller financing.

There are two main advantages to a seller holding a mortgage.  The first is to receive a higher rate of interest on the sale proceeds than might otherwise be available through alternative sources, such as a bank account.  The second is the ability to defer capital gain on the sale proceeds until a future year when the deferred payments of the purchase price are received. 

Likewise, there are two main advantages to the buyer by having the seller hold a mortgage.  First, the rate of interest charged by the seller is usually lower than the rate of interest a financial institution may charge the buyer.  Second, the closing costs to the buyer may be less than if the buyer obtains a loan from an institutional lender.

In this article, we will explore what the seller must do if the seller has agreed to hold a mortgage but needs to enforce the seller’s rights because the buyer failed to perform the buyer’s obligations under the mortgage.



Before we explore how a seller goes about enforcing rights under a mortgage, it is necessary to know what documents the seller receives from the buyer at the closing if the seller has agreed to hold a mortgage.  At the closing, the buyer gives the seller, as part of the purchase price, a document by which the buyer promises to pay the seller the balance of the purchase price over time usually at a stated rate of interest (this document is called a note) and grants the seller a lien on the real property purchased as security for the buyer’s promises made in the note (this document is called a mortgage).  The mortgage usually contains other terms too, such as requiring the buyer to maintain the property, pay the taxes and keep the property insured, among others.  Under the note and mortgage, the buyer is commonly referred to as the borrower or mortgagor and the seller is commonly referred to as the lender or mortgagee.  We will use these terms in the rest of his article.



If the borrower fails to perform an obligation under the note or mortgage, the lender may be able to consider the borrower to be in default.  However, before the lender can consider the borrower to be in default, the lender must be sure to comply with the lender’s obligations under the note and mortgage that may have to be satisfied before the lender can take legal action to enforce the note or mortgage.  For example, the note or mortgage may contain a clause that requires the lender to give the borrower a notice of what the borrower failed to do and may require the lender to provide the borrower an opportunity to correct the problem.  Therefore, it is important that the note and mortgage be examined carefully to determine what the lender needs to do before any legal action is taken to enforce the note or mortgage.



1.  Lender’s Election of Remedies.  

If the borrower fails to perform an obligation under the note or mortgage and the lender has provided the borrower with the notices and opportunity to cure as may be required by the note or mortgage, the lender then has to decide whether to seek to enforce the lender’s rights under the note or under the mortgage.  Under New York law, a lender must make an election as to which document should be enforced since the lender cannot bring an action to enforce both at the same time.  If the lender makes an election to bring a lawsuit to enforce the note, the lender generally cannot start a foreclosure proceeding until the lender obtains a court judgment on the note and is unsuccessful in collecting on the judgment.  Likewise, if the lender decides to start a foreclosure proceeding to enforce the mortgage, the lender cannot bring a separate lawsuit to enforce the note.  This is what is referred to as an election of remedies.


2.  Pre-Action Notices  

If the borrower is a natural person, the debt was incurred for personal, family or household purposes and the mortgage is a lien on property that is a one to four family residential dwelling or condominium used or occupied (or intended to be used or occupied) in whole or in part as the home or residence by one or more persons and which is or will be occupied by the borrower as the borrower’s principal residence a notice may be required to be given to the borrower 90 days before starting any foreclosure proceeding.  This notice is in addition to any notice that may be required under the note or mortgage.  While the law seems to require a 90 day pre-foreclosure notice for institutional lenders, due to some uncertainty under the law, some Judges require that a 90 day pre-foreclosure notice be given where the mortgage is privately held, such as in the case where the seller holds a mortgage as part of a sale.  In addition, anyone who has purchased a mortgage (for investment or any other reason) from a lender that is bound by the requirements for a 90 day pre-foreclosure notice is also bound by the pre-foreclosure notice requirements under the law.  In addition, it may be necessary to register the 90 day pre-foreclosure notice with the State Banking Department.


3.  Pre-Foreclosure Process  

Once the decision has been made by the mortgagee to start a foreclosure proceeding, the mortgagee will need to determine who has an interest in the property and, whether that interest is subordinate (or sometimes called junior) to the lien of the mortgage being foreclosed.  Anyone having a subordinate or junior interest must be made a party to the foreclosure proceeding.  Examples of interests that are junior to a first mortgage being foreclosed are interests such as a second mortgage (e.g. a home equity loan), interests of tenants who became tenants after the mortgage became a lien on the property, judgment creditors who have been granted a judgment after the mortgage became a lien on the property, as well as others.  The failure to name any party with a junior interest to the mortgage being foreclosed means that the successful bidder at the foreclosure sale will be purchasing the property subject to the rights of the junior interest.  For example, if there is a tenant on the property who is not made a party to the foreclosure proceeding, the tenant’s rights, whatever they may be, will survive the foreclosure proceeding and the purchaser of the property at the foreclosure sale will have to honor those rights.  This may affect a person’s willingness to bid on the property at the foreclosure sale (discussed below).  Real estate taxes are never subordinate to the lien of a mortgage, even if the tax did not first come due until after the mortgage became a lien.


4.   Foreclosure Process-Pre Sale

Once the parties to the foreclosure proceeding are determined, a Lis Pendens, or Notice of Pendency, is filed with the County Clerk to put the world on notice that a foreclosure proceeding is about to begin.  Anyone who obtains an interest in the property after the Lis Pendens is filed need not be named a party to the foreclosure proceeding but will still have that interest cut off by the foreclosure proceeding.  The parties to the foreclosure proceeding are then served with the Summons and Complaint. 


If the property is an owner occupied one to four family dwelling, special notices must accompany the Summons and Complaint that is served on the owner and tenants of the property.  One of the notices required is intended to inform the owner that the owner can lose the property through the foreclosure process and to let the owner know that the State encourages the owner to seek assistance in learning of the options that may be available to the owner.  In addition, if there are tenants who occupy any other part of the property, those tenants must also receive a notice directed to their rights as tenants.  The rights of tenants post foreclosure are discussed later on.


In a foreclosure of residential property in which the borrower is a resident, the court is required to hold a settlement conference within 60 days after the lender files proof that the borrower was served with the papers that are used to start the foreclosure, and the law mandates that both the lender and borrower negotiate in good faith to settle the foreclosure, which may require a loan modification.  Even if the note and mortgage allows the lender to collect legal fees to enforce the mortgage, the lender is not entitled to be reimbursed for legal fees incurred in attending the settlement conference. 


Assuming there are no defenses to the proceeding raised by anyone made a party to the foreclosure proceeding, and the lender and borrower cannot reach a settlement, a Referee is appointed by the Court to compute how much is owed to the lender.  Once that is determined, the lender obtains a Judgment of Foreclosure which then allows the lender to have the property sold at auction by a Referee.  The law requires that notice of the sale of property be published in a newspaper from between 3 to 4 weeks before the sale, and sometimes the notice of sale has to be posted.  


Once a Judgment of Foreclosure and Sale is obtained permitting the Referee to sell the property, the lender has the obligation to maintain the property if the property is residential property (including mixed residential and commercial use) between the time the Judgment is obtained and the time title to the property is transferred by the Referee if the property is vacant, becomes vacant, or is abandoned by the borrower but occupied by a tenant.  There are some exceptions and suspensions, and technicalities as to what is meant by maintaining the property and if this applies, consultation with an attorney is a must.


5.   Foreclosure Process-Sale  

On the scheduled date of the sale, the Referee will conduct an auction of the property.  The lender usually, but not always, opens the bid for the property for the amount owed to the lender.  If the property is worth less than what is owed to the lender, the lender may open the bid for the value of the property.  Others are then invited to bid until a high bidder is determined by the Referee.


The sale of the property conducted by the Referee will be subject to Terms of Sale that are determined and usually read before the bidding starts.  The terms of sale usually provide for the following:


·         10% down (bank draft or cashier’s check) at the auction


·         Close within 30 days, sometimes less time is provided-Time is of the essence (if late, interest is usually charged at 9% per annum).


·         The Referee will provide a deed, but usually nothing else.  The obligation to obtain a title search, survey etc. is the purchaser’s responsibility.


·         The sale is usually subject to any state of facts a survey of the property will show.  What this means is that if, for example, a survey will show a title defect (like a driveway located entirely on a neighbor’s property), the Referee has no obligation to fix the problem.


·         The purchase is “as is”, with no right to inspect.  The reason there is no right to inspect is because the property still belongs to the owner who took out the mortgage until the property is sold.


·         The purchaser is responsible for obtaining whatever title documents, including a survey, the purchaser desires to have examined before the closing.  Neither the lender nor the Referee has any obligation to provide any title documents other than the Referee’s deed.


·         The purchaser is responsible for all closing costs (tax, recording fees, title insurance etc.).


·         The deposit paid at auction will be lost if the purchaser fails to close on time.  If the purchaser does fail to close on time, the property is usually sold to the next highest bidder at the auction.


·         Some auctions are conducted that result in a sale of the property subject to any existing property taxes.  While the law does require the property taxes to be paid out of the proceeds from the auction, some sales are made that pass this obligation onto the purchaser.  Therefore, it is important to understand the terms of sale so as to avoid any surprises.


If the Referee improperly conducts the foreclosure sale, the validity of the sale could be called into question.


6.   Foreclosure Process-Post Sale  

Once the property has been sold and the Referee has given a deed to the purchaser at the foreclosure sale, the Referee is required to file a report of the sale with the Court.  The Court, upon application, will in most cases approve the Referee’s Report of Sale.  Although this is an important step in the foreclosure proceeding, there are many instances where this is not done.  Even if all the steps required to be taken in the foreclosure proceeding were properly taken, if the former owner of the property refuses to vacate the property, the purchaser is responsible for evicting the former owner.


If the property is in any manner used as residential property (including mixed residential and commercial use), the purchaser of the property (which may be the lender) needs to provide a notice to the tenants advising that they may have the right to remain on the property until the later of the end of the lease term or 90 days from the mailing of the notice.  This right is in addition to any other right of the tenants such as the rights a tenant may have by not being named a part to the foreclosure proceeding.


7.   Foreclosure Process-Special Issues  

Sometimes the foreclosure proceeding can be delayed or there may be some particular interest in the property that could affect the finality of the sale.  Some of these issues are as follows:


·         The bankruptcy filing by the owner of the property during the foreclosure process (sometimes even on the eve of the foreclosure sale).  If a bankruptcy proceeding is filed, the foreclosure proceeding must stop until the lender receives permission from the Bankruptcy Court to proceed with the foreclosure.


·         If the United States government has a lien against the property, the United States has what is called a right of redemption-i.e. it has between 120 days and 1 year from date of sale to match the purchase price and take the property. 


·         Appeal from the Judgment of Foreclosure if there is a contested foreclosure proceeding. 


·         The foreclosure of a second or third mortgage may trigger a due on sale clause of a senior mortgage.  This means that immediately following the sale of the property by the Referee to the purchaser, the holder of the senior mortgage can demand payment in full on the debt secured by its mortgage, and if there is a failure to pay, the holder of the senior mortgage can start its own foreclosure proceeding.


8.   Borrower's Right to Recover Legal Fees

Legislation has been passed providing for recovery of legal fees by borrowers against lenders under certain conditions. If, as is common, a mortgage provides that the lender is entitled to recover legal fees if the lender forecloses the mortgage or if the borrower fails to perform an obligation under the mortgage, then the borrower has an implied right to recover from the lender legal fees incurred by the borrower if the borrower successfully defends against a foreclosure proceeding or if the borrower incurs legal fees arising out of the lender's failure to perform an obligation under the mortgage. This is an implied right which means it applies even if the mortgage has no provision for recovery of legal fees by a borrower, as is commonly the case. However, this implied right to legal feels is limited to those mortgages that cover a 1-4 family owner-borrower occuppied property or condominium unit. (See generally Real Property Law §282).


Structuring a sale so that the seller is holding a mortgage for part of the sale price can have benefits for both the seller and buyer.  However, the seller may need to comply with certain obligations before any legal action is taken against a defaulting buyer.  If you are considering holding a mortgage as part of a sale, you should contact an attorney before a contract is signed to let your attorney know of your plans so that you and your attorney can discuss the process in case you are faced with a defaulting buyer and to discuss other steps that might be taken in an attempt to protect your interests.





IRS CIRCULAR 230 Disclosure:  To ensure compliance with requirements imposed by the IRS, please be aware that any U.S. federal tax advice contained in this communication (including any attachments or enclosures) is not intended or written to be used and cannot be used for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or (ii) promoting, marketing or recommending to any other person any transaction or matter addressed herein.


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Last Update: March 28, 2011