In a typical home sale, the buyer obtains a loan from a bank and the seller receives the full price at closing. In seller financing, also called owner financing, the seller acts as the lender. The buyer makes a down payment and then pays the seller over time under the terms of a promissory note. The note is secured by the property, so if the buyer stops paying, the seller can pursue the remedies provided by the loan documents and state law.
How It Works
- The buyer and seller agree on the price, down payment, interest rate, payment schedule and term.
- A promissory note records the buyer's promise to pay.
- A deed of trust or mortgage secures the note and is recorded in the county records.
- The buyer makes monthly payments, often through a loan servicing company that tracks payments and sends statements.
Common Structures
- Fully amortizing loan. Payments cover interest and principal and pay off the balance over the term.
- Balloon payment. Payments are calculated over a long period, such as 30 years, but the balance becomes due in a lump sum after a shorter period, such as five or ten years.
- Interest-only periods. The buyer pays only interest for a time before principal payments begin.
- Wraparound loans. The seller's note includes an existing mortgage; these arrangements are complex and require careful legal guidance.
Benefits for Sellers
- A broader pool of potential buyers, including those who may have trouble qualifying for conventional loans.
- A steady stream of income and interest.
- Potential tax advantages through spreading gain over several years under installment sale rules, subject to individual circumstances.
- Possible faster closing than a bank-financed sale.
Risks to Understand
- The buyer may default, requiring the seller to take action, which can be costly and time-consuming.
- The seller's money is tied up in the note rather than received in cash.
- Regulations such as the Dodd-Frank Act and state licensing rules can apply to seller financing in some cases.
- If the property has an existing mortgage, a due-on-sale clause can create complications.
Protecting Yourself
Use a real estate attorney to draft the documents, verify the buyer's finances and credit, require adequate down payment, and ensure the buyer maintains insurance and pays property taxes. Consider using a loan servicing company so that payments and escrow are handled professionally and records are accurate.
Selling the Note Later
Many sellers eventually decide they would prefer a lump sum rather than waiting for monthly payments. A note can be sold, in whole or in part, to an investor. The price depends on the interest rate, the payment history, the property value, the borrower's credit and the remaining term. Buyers typically pay less than the unpaid balance, reflecting risk and the time value of money. A partial sale allows you to receive some cash while keeping the remaining payments.
Next Steps
If you are considering selling a property with owner financing or selling an existing note, gather your documents, speak with an attorney and compare offers. This article is general information and not legal, tax or financial advice.
