When most people buy a home, they go through the typical home-financing process of finding a lender, submitting financial documents, completing paperwork, and then waiting a month or two to be approved for a new home loan.
However, with home prices and interest rates climbing recently, buyers and sellers are increasingly looking for innovative ways to structure real estate deals.
One solution is seller financing, in which a home seller essentially acts as the bank in a home purchase — allowing the buyer to make payments over time and bypass the traditional mortgage approval process.
Seller financing is a common strategy among real estate investors. Still, it can also provide significant opportunities for traditional home sellers — offering a path to homeownership (or home sale) that would otherwise be unattainable.
What is seller financing in real estate?
Seller financing, also known as owner financing, is where a property owner allows the buyer to purchase their property over time rather than getting a loan from a bank or mortgage lender to buy it outright.
In a traditional home sale, the seller typically receives a lump sum from the buyer's lender for the entire agreed-upon sale price at closing, minus closing costs and whatever amount remains on the seller's mortgage.
With seller financing, rather than a single payout, the seller receives an initial down payment from the buyer plus a series of monthly mortgage payments. The specific loan terms are left entirely up to the homeowner and buyer.
Seller financing can be especially useful when a mortgage is hard to obtain, or a homeowner wants to expedite the sale process. It can also be beneficial when a seller owns their property outright and prefers a consistent cash flow over a single lump sum (often for tax benefits or the dependability of a monthly payment).
🏠 Alternative terms for seller financing
When looking for seller financing opportunities as a buyer, or listing a property with seller financing as a seller, be aware that different terms in the market may refer to it:
- Owner financing
- Owner backed mortgage
- Holding a note
- "Owner carry"
- "Seller carry"
Sellers often use these terms when listing their properties, so understanding them can help you identify more potential deals or locate motivated buyers quicker.
How seller financing works
In a typical real estate transaction, the buyer obtains a mortgage loan from a bank to finance the property. The lender provides the funds upfront to the seller, and the buyer then repays the lender over time through the mortgage, complete with set interest rates and terms. Seller financing follows a slightly different approach.
With seller financing, the original homeowner becomes the bank instead of going through a third-party lender. The buyer and seller enter into a contract in which the seller provides the mortgage directly to the buyer.
The parties will agree on loan terms like interest rate, repayment schedule, down payment, and other provisions. This is typically done through proper documentation, like a promissory note.
The property is used as collateral for the loan, and the seller keeps the title or deed until the loan is fully repaid. Once the property is completely paid off, the seller transfers ownership and title to the buyer.
Benefits of seller financing
With seller financing, sellers receive an ongoing income stream encompassing the sales price plus interest. Meanwhile, the buyer doesn’t have to apply for traditional mortgage financing.
With the mortgage lender essentially removed from the process, seller financing allows for a much more straightforward and faster sales process. It can even result in homeowners earning more from their property over time.
Mike Bennett from Clever explains, “Sellers can earn as much as 110% to 120% of their property’s value. This is mainly because of interest in payments and getting paid out equity monthly. In short, seller finance will get the absolute most out of a property paid out over time.”
Homeowners can also reap significant savings on capital gains taxes — estimated at around 20% to 30% of the sale price.
Buyers can also benefit from seller financing, especially if they’re looking to bypass a traditional mortgage, prioritize a faster closing process, or save on realtor fees.
Types of seller financing
Seller financing or owner financing is generally a simple and clear process. That said, it can be helpful to familiarize yourself with the different agreements under this umbrella.
1. Land contracts
Also known as a contract for deed, this approach often comes to mind when envisioning a seller financing arrangement. Sellers retain the legal title to the property until the buyer has paid off the full purchase price plus interest over the agreed-upon term.
The buyer will make periodic payments to the seller and take possession of the property but doesn’t officially get the deed until the final payment. Often, land contracts have a lump-sum balloon payment at the end of the loan term.
2. Rent-to-own
In the rent-to-own scenario, the buyer leases the property from the seller for a set period, with a portion of each rent payment going toward an eventual down payment on the home. After the lease period, the buyer can buy the property outright.
This setup can be particularly helpful if a buyer is looking to secure a property while also taking the time to improve their finances for a mortgage.
3. Wraparound mortgage
A wraparound mortgage is a distinct type of seller financing where the seller's existing mortgage remains outstanding. However, the buyer makes an additional mortgage payment to the seller, usually at a higher interest rate.
The seller then uses the buyer's payment to pay their mortgage with the lender, pocketing the difference as their income stream. From the lender's perspective, only the seller's original mortgage exists.
When is seller financing typically used?
In a few scenarios, a seller financing arrangement may be particularly beneficial over a traditional home sale or straight cash offer.
Slow real estate markets
In a buyer's market or during economic downturns when homes take longer to sell, seller financing might help sellers attract a broader pool of potential buyers.
Buyers who have trouble qualifying for a traditional mortgage may be able to turn to seller financing as an alternative. This is especially true for those struggling with poor credit or who need more time to obtain cash for a down payment.
Offering seller financing can help entice buyers when few are qualified for mortgages and even help make a listing more attractive.
Unique or traditionally non-conforming properties
Properties that are unconventional or otherwise don’t meet the rigid standards that some lenders impose may be good candidates for seller financing.
These include properties with unusual architectural styles in remote locations or homes needing significant repairs. When traditional mortgage lenders hesitate to approve a loan, seller financing can ensure the transaction goes through.
Investment properties
Real estate investors often use seller financing when purchasing investment properties. Securing funding directly from sellers can be easier than through traditional lenders.
For example, a house flipper may fund their fix-and-flip project through the existing owner rather than with a bank loan.
On the other hand, a seller may also opt for seller financing to rent out their property and obtain a steady income stream without necessarily becoming a landlord.
» Learn how much a real estate investor will pay for your house
What are the advantages of seller financing?
For sellers
- Potential to maximize profits: Sellers stand to earn interest on the sales price of their property, resulting in a potentially greater payoff compared to the traditional sales process alone.
- Passive income stream: Seller financing allows homeowners to receive a steady income stream over time. Plus, the deal is backed by the property, adding an extra layer of stability.
- Tax benefits: In many cases, sellers can defer capital gains taxes by structuring the sale as an installment sale, spreading the tax liability over multiple years.
- Faster sale: By providing financing, sellers eliminate the need to work with third-party mortgage companies, appraisal firms, and even realtors. With fewer parties involved, the sales process moves more efficiently and quickly.
- Flexibility: Sellers can tailor the financing terms to their preferences, such as the interest rate, repayment period, and down payment requirements.
For buyers
- Save on fees: By bypassing the conventional lender, buyers may avoid loan origination fees, underwriting costs, and other charges levied by banks and mortgage companies.
- Easier qualification: Seller financing provides an alternative financing option for buyers who may not qualify for traditional mortgages due to factors like poor credit or illiquid funds for a down payment.
- Potential for better terms: Sellers may be willing to offer more favorable financing terms, such as lower interest rates or flexible repayment schedules, compared to traditional lenders. While it’s not a given, it’s worth negotiating.
- Access to unique properties: Seller financing can open up opportunities for buyers to purchase unique or non-conforming properties that may not qualify for traditional financing, like properties sold in as-is condition.
- Property ownership: Seller financing allows buyers to become property owners immediately and start building equity, even as they work on improving their finances.
What are the risks of seller financing?
For sellers
- Default and foreclosure risk: The buyer may default on loan payments. If this happens, sellers will have to navigate the foreclosure process to regain possession of the property.
- Lack of professional oversight: Traditional mortgages involve oversight from regulated lenders and underwriters. With seller financing, sellers must vet the buyer's creditworthiness and ability to make payments independently.
- Tax implications: As with any real estate transaction, sellers must diligently navigate taxes, especially by reporting interest income properly to the IRS.
For buyers
- Fewer regulations: Traditional mortgages are covered by certain regulations and consumer protection laws. On the other hand, seller financing contracts are private agreements without the same safeguards.
- Lack of pricing insight: Most seller financing transactions happen without an appraisal, which means buyers may not be fully sure of the property’s value. This can lead to a situation where a seller marks up their price.
- Potential for more expenses: Buyers may face higher interest rates or a bigger down payment depending on their qualifications and how the deal is negotiated.
At the most basic level, the seller financing deal consists of finding a tenant-buyer, getting them approved, and closing out promptly. Here’s what you can expect the process to look like.
Tips for sellers
Be upfront about offering seller financing
You’ll want to immediately advertise that you’re offering seller financing in your property’s listing. During open houses or inquiries, remind prospective buyers of your offering and that you can negotiate on terms.
Verify a buyer's qualifications
As you receive prospective buyers, it’s critical to vet each one’s creditworthiness, income, employment status, and ability to make payments over the loan term. You can request documents like tax returns, pay stubs, and bank statements to help safeguard against default risk.
Determine financing terms
It’s up to you and the buyer to negotiate the loan amount, interest rate, repayment period, down payment, and balloon payments. Make sure to put everything in writing and the terms you agree to are documented and compliant with lending laws.
Consider working with an attorney
Consulting with an attorney or another financial professional can help you correctly navigate the transaction's legal complexities and tax implications.
An attorney can also help draft important legal documents to legitimize the transaction and protect your interests.
These include a promissory note outlining the loan terms, the interest rate, the payment schedule, any penalties for late payments or defaults, and a comprehensive purchase agreement for signing.
How do you set up a seller financing contract?
Once the buyers have met the seller’s requirements for being offered seller financing, both parties need to work together to develop a contract for the sale.
Similar to a contract you would sign when you get a mortgage, this document will outline the down payment, interest rate, payment specifics, and other aspects of the deal.
Unlike a standard mortgage payment, these specifics aren't determined by the rules that govern standard real estate contracts.
As you may have noticed, nothing about seller financing is typical — but there are a few things that seem to be more common in seller financing contracts:
- Higher down payments: While nothing about seller financing stipulates this, owners often ask for high-interest down payments to pay off whatever is left of their loan or to feel more comfortable acting as lenders.
- Higher interest rates: Since a seller’s money is locked up in a financing scenario rather than available to be invested elsewhere, seller financing often comes with higher rates than a traditional mortgage.
- Balloon repayment: Sellers don’t want to be tied to collecting home payments for 30 years! Because of this, contracts often have a balloon repayment clause stating that the full loan value will become immediately due in some predetermined amount of time. By or before this point, the buyer would have to find another loan, pay off the house some other way (in cash or selling), or lose the property.
Remember that the terms of your contract can vary wildly depending on the property you're purchasing.
Suppose the seller chooses to carry a note because other types of mortgages aren’t available for the home. In that case, the buyer may get similar terms to those a typical mortgage might offer, simply because the seller wants to get money out of the property.
Do your research on all seller-financed homes to ensure that reselling them in the future will be relatively easy if you’re interested in that option.
That said, whatever you choose to do, always have a lawyer look over any sort of contract before you sign it!
What are the typical terms in a seller financing arrangement?
The purchase price is probably the most fundamental term. While there’s no set rule for calculating the sale amount, a good place to start is evaluating its fair market value based on recent comparables.
From there, buyers are often required to pay a down payment to the seller. This can help mitigate risk and provide buyers with immediate equity.
According to Mike Bennett from Clever, “the industry standard is around 20%.” However, depending on individualized circumstances, a different percentage can be negotiated.
Other key terms include:
- The interest rate is usually higher on seller financing arrangements than conventional mortgages to compensate the seller for the increased risk.
- The monthly payment amount is based on the purchase price, interest rate, and loan term.
- The loan term or amortization period is typically 3 to 10 years.
Additionally, seller financing arrangements often include a balloon payment, a lump sum paid at the end of the mortgage term. Termination fees and whether or not prepayment penalties apply are also important to specify.
Finally, outlining any additional rights and responsibilities between the seller and buyer is critical. These can be customized according to your unique situation and may cover things like who pays property taxes and who covers repairs during the loan term, among other things.
Where can a buyer find seller financing deals?
Seller financing is still pretty rare, since it requires the seller to take on additional risk. Because of this, the easiest way to find a property with seller financing is to search specifically for homes already offering it.
You can find many seller-financed homes on real estate websites like Zillow. For example, when I enter "owner financing" as a keyword into my Zillow property search, it returns all the listings in which the owner advertised that they would be willing to carry the note.
Buyers can also ask an owner if they would be open to seller financing. While this can feel intimidating, the worst they can do is say no, and you can either find a traditional source of funding or simply move on.
Finally, there are a few factors that may mean a seller may be more open to owner financing:
- The house is listed "For Sale By Owner" (FSBO): There is more room for person-to-person negotiation in this type of transaction.
- You've developed a good relationship with the owner. Seller financing is common between tenants and landlords ready to sell their rental property. The more the owner knows you, the more willing they may be to trust you to make your payments on time.
- It isn’t the seller’s only home: If someone is selling a rental property or second home, they’re less likely to need the lump sum of a traditional mortgage to purchase their next primary residence.
By understanding these dynamics and actively searching, you can increase your chances of finding a seller-financed property that meets your needs
FAQ
Is seller financing a good idea?
Seller financing is an alternative path for real estate transactions that can benefit buyers and sellers in many ways. Sellers may be able to maximize their profitability, defer capital gains taxes, and even enjoy the perks of being a landlord without as much of the hassle. Buyers can also benefit from increased flexibility and accessibility to property ownership.
That said, seller financing isn't a one-size-fits-all solution. Both parties must know the potential risks and take proper legal and financial precautions. Seller financing can create a win-win outcome when thoughtfully structured with safeguards and protections.
Who holds the title in a seller financing arrangement?
In most cases, the seller will retain legal title/ownership of the property until the buyer has fully repaid the mortgage. Once paid off, the seller will transfer the ownership to the buyer.
What's the typical interest rate with seller financing?
Interest rates on seller financing arrangements vary heavily depending on broader market rates and a buyer’s qualifications. However, seller financing rates generally tend to be higher than traditional mortgages. A good rule of thumb is to add 1-4 percentage points to current market rates.
Can you avoid capital gains tax with seller financing?
While you can’t fully avoid capital gains tax with seller financing, you may be able to defer them. Most sellers can defer the capital gains tax to the end of the loan term when the sale closes since it’s an installment sale.
What is a balloon payment at the end of a mortgage term?
A balloon payment is a large lump sum due at the end of a mortgage's term to fully pay off any remaining principal balance on the loan. It’s a common practice in seller financing agreements and can be combined with or even replaced by a down payment.
