What is seller financing?

High interest rates and low housing inventory might have you looking for alternative ways to finance a home purchase. If you’re not in the position currently to take out a mortgage, or are looking for a short-term financing solution, you might be considering seller financing.

Seller financing is a real estate financing option where the seller acts as the lender. The terms are decided on by the buyer and seller and written into a contract. It may allow you to buy a home without going through traditional mortgage financing, such as from a bank or credit union. Here’s how seller financing works, pros and cons, and how to arrange seller financing. 

How does seller financing work?

Seller financing is a type of owner financing known for its flexibility. Sellers and buyers can negotiate directly to determine the terms of the seller financing arrangement. The contract details are worked out between the buyer and seller directly.

Because owner financing is typically expected to be short-term, they’re often written with a balloon payment due at the end of the loan term. The buyer is expected to get financing elsewhere to pay off the seller to complete their contract. 

Write out terms in a seller financing addendum

The two parties involved can agree on repayment terms, interest rate and down payment in a seller financing addendum. 

“Typically, seller financing is negotiated via a seller financing addendum to the contract, which outlines the rate, length of loan, type of payments, etc.,” said Lindsey Harn, a top real estate agent with Christie’s International Real Estate in San Luis Obispo County.

Order a title search and open escrow

Aside from the seller financing terms, the transaction proceeds like any other mortgage loan would. The buyer and seller are responsible for opening escrow and ordering a title search with the title company. This is important, especially in a seller-financed transaction, to ensure there aren’t any other claims, liens, or encumbrances on the title. 

Transfer title to the buyer

“Once the property is purchased, the buyer takes the title, and the loan/note is recorded to show the seller's interest in the property,” Harn says. 

The buyer will need to sign:

• A promissory note: This document is a promise from the buyer to repay the seller for the amount and date agreed upon.
• Deed of trust or mortgage: This is the security instrument for the promissory note that allows the seller to foreclose if the buyer fails to make payments.

After these are signed, the seller may transfer the title to the buyer and the transaction is filed with the county recorder. In some types of seller financing, the seller may hold onto the title until the mortgage is paid. 

Service the loan

With the seller acting as lender, they also need to collect payments. The seller can hire a third party to do this, since this process can become complicated if the buyer doesn’t make payments on time. 

The seller will hold the loan until maturity or the buyer pays it off. This is usually for a date in the near future — typically five years or less. 

Here’s how conventional mortgages compare with seller financing:

What are the types of seller financing agreements?

There are a lot of names for seller financing. There are also different ways seller financing can be structured:

• Land sale contract, contract for deed, or installment sales contract: In a land sale contract, the buyer and seller agree to installment payments and joint ownership until the buyer has paid off the loan. The seller transfers the deed to the buyer once the loan has been paid off. 
• Lease-to-own or lease-purchase agreement: Lease-to-own agreements designate a portion of the buyer’s monthly payment to go toward the purchase price of the home. It acts like an option the buyer can use to buy the property at a future date. With a lease-to-own agreement, the buyer isn’t contractually obligated to buy the property, but with a lease-purchase agreement, the buyer is. The seller doesn’t transfer the title until the buyer exercises their option to buy the property. 
• Junior mortgage or purchase money mortgage: With a junior mortgage or purchase money mortgage, a seller will finance a smaller part of the home’s purchase price. A traditional lender holds the larger mortgage.
• Assumable mortgage: With an assumable mortgage, the seller signs over their existing mortgage and title to a new buyer. Only certain types of loans in specific years qualify (FHA, VA and USDA loans, typically) and it only makes sense if the seller has a low interest rate and the buyer can compensate the seller for the difference in equity.
• Subject-to mortgage: Mortgages that are written “subject-to” (also colloquially called “sub-to”) are where a new buyer takes over the mortgage without changing the existing mortgage or lender. The new buyer takes the title, but keeps the mortgage in the seller’s name without informing the lender. (That’s also why it’s considered seller financing.) The new buyer would continue making payments on the mortgage without formally having the loan in their name.

What are the benefits of seller financing for sellers and buyers?

Seller financing has a number of benefits, for both the buyer and seller. 

Here are some ways seller financing benefits the buyer:

• Fewer closing costs: Buyers aren’t paying for lender fees. That eliminates the origination fee, mortgage points, appraisal, mortgage insurance, escrow fees and more. 
• Faster closing time: Since your transaction isn’t contingent on lender financing, the time it takes to close is much faster. 
• More flexible loan terms: Buyers who can’t qualify for a mortgage or are looking for non-traditional financing can benefit from the flexible loan terms seller-financed agreements can offer. 
• Possibly more flexible credit qualifications: Sellers don’t have underwriters that require a certain credit score, debt-to-income ratio and other factors lenders typically look at. There’s potential for homebuyers to get financing who otherwise wouldn’t meet requirements. 

Here are some benefits for the seller:

• Attract more buyers: Seller financing may appeal to potential buyers who need alternative financing to get into a home. 
• Faster closing time: By forgoing the lender, you’re also foregoing lender requirements, which typically prolong the closing process. 
• Capital gains/taxes: Sellers can spread the capital gains over time with a seller-financed agreement, paying taxes on the money each year as opposed to in a lump sum at sale time. 
• No appraisal: Seller financing doesn’t require an appraisal like lender financing does. 
• Fewer repair or inspection costs: Without a lender, sellers may be able to avoid certain repair and inspection costs. 

What are the drawbacks of seller financing for sellers and buyers?

Seller financing has some drawbacks for both buyers and sellers. Consider these carefully before writing up a seller-financed contract.

Here are some drawbacks of seller financing for the buyer:

• Short pay-off period: Seller financing isn’t intended to be permanent. It’s ordinarily used as a short-term agreement between the buyer and seller that is paid off after around five years. Eventually, the buyer will need to refinance the loan anyway. 
• Balloon payments: Along with the shorter time frame, buyers are also looking at a balloon payment at the end of the contract. In theory, buyers should be able to obtain another loan at that time, but it could become problematic if they still have issues with their credit score, income, or debt levels. 
• High prices and large down payments: Many homes advertised as seller-financed properties have high prices, high interest rates and require large down payments. They may not be the right choice if you’re looking for more affordable options or lower interest rates. 

These are drawbacks for the seller:

• Paperwork: It’s up to the seller to write up the legal agreement, order a title search and oversee transfer of the title. 
• May need to act as loan servicer: Collecting payments and keeping records isn’t for everyone, and if your buyer isn’t reliable, it can be a real pain. 
• May need to foreclose: If the buyer doesn’t fulfill their end of the contract, the seller may need to foreclose on the property. 
• Tax due: If a seller receives interest income, it’s considered taxable and they’ll need to report it to the IRS. 

What is the process of setting up seller financing?

Seller financing comes with flexible terms that both the buyer and seller can agree upon. The seller financing addendum typically includes:

• Who is responsible for the creation of legal documents
• Principal amount of the loan 
• Interest rate
• Payment amount
• Balloon payment amount
• Date of first payment
• Length (term) of the mortgage
• Down payment
• Late payment charges
• Where to pay property taxes, homeowners association dues and homeowners insurance
• Who pays for title insurance
• Other terms

There needs to be a lot of trust when setting up seller financing and the terms need to be clear. If you’re worried about the contract in any way, be sure to hire a real estate attorney. 

What is seller financing FAQ

Can anyone offer seller financing?

Seller financing works best when the property is owned free and clear. Most lenders have a due on sale clause, which doesn’t allow sellers to finance a new buyer if they still have a mortgage.

How does a balloon payment work in seller financing?

A balloon payment is a large, one-time payment at the end of a mortgage. Balloon payments are common in seller-financing arrangements that are expected to be short-term. Typically, the seller expects the buyer to obtain new financing at a certain point and pay off the seller-financed loan in its entirety. 

Are there risks involved with seller financing?

For the seller, one of the biggest risks is if the buyer defaults on payment. In that situation, you would take on the lender's responsibilities, such as handling loss mitigation and foreclosure. 

How do I protect myself in a seller-financed deal?

If you’re worried about being taken advantage of, you may want to hire an attorney who specializes in real estate contract law. You may want them to draft the contract and addendums, or at the very least, look over your paperwork.