When a seller allows a buyer to make payments over time for the purchase of property, it’s known as seller financing.
This private financing by the seller takes the place of a bank loan or is in addition to a conventional mortgage.
The buyer and seller agree upon the payment amount, interest rate, and other terms. The amount financed by the seller will depend upon the buyer’s down payment and whether there are any bank loans.
Example
Here’s an example of how it works.
An owner advertises his or her house for sale, either on her own or through an agent.
A buyer makes an offer, and they agree upon a sales price of $175,000 with a 10 percent down payment of $17,500.
Rather than requiring the buyer to obtain a bank loan, the seller carries back the balance of $157,500 in the form of a note and mortgage. (It could also be a note and deed of trust or a real estate contract, depending on the customary documents for that state.)
A title company or real estate attorney is often used for the closing.
The note spells out the terms of repayment.
In this case, they agree upon 8.5 percent interest at $1,211.04 per month based on a 360-month amortization.
This seller doesn’t really want to wait a full 30 years for payments, so the note requires payment in full, known as a balloon payment, within seven years.
Private Mortgage = Cash Now
Since the buyer makes payments to the seller rather than an institutional lender, the legal arrangement is called a private mortgage. Other names for this type arrangement include seller carry-back, installment sale, or seller financing.
The seller has the same mortgage rights as a bank, so if the buyer does not make payments, the seller can foreclose and take the property.
When the seller prefers cash today rather than payments over time, the rights to future payments can be sold or assigned to a note investor on the secondary market.