Exit Structures
Seller Financing
When you finance the buyer yourself, you become the lender. Learn about traditional seller financing, land contracts, and wraparound mortgages—and their risks.
When someone offers to "carry the note" or proposes "owner financing," they could be describing any of three different arrangements. This page explains what each structure actually is, how they differ, and what sellers need to understand about each one.
Seller Financing Takes Three Distinct Forms
When someone proposes "seller financing," they could mean any of three different structures with fundamentally different mechanics.
In traditional seller financing, title transfers to the buyer at closing. The seller holds a promissory note secured by a mortgage or deed of trust—the same security instruments banks use. The buyer owns the property from day one; the seller holds a lien.
In a land contract (also called "contract for deed"), the seller keeps legal title until the contract is paid in full. The buyer takes possession and makes payments, but doesn't receive the deed until the final payment. The buyer has equitable title—the right to become the owner—but not legal title yet.
In a wraparound mortgage, title transfers to the buyer at closing, but the seller's existing loan stays in place. The buyer makes payments to the seller, who remains responsible for the underlying loan. The wrap "wraps around" the existing mortgage, creating a new loan that includes it.
These are not variations of the same structure. They differ in when title transfers, what security the seller holds, and what risks each party carries.
What Recovery Actually Looks Like
Regardless of which structure a seller uses, default means recovery—and recovery is more complicated than most sellers expect.
Foreclosure Is Neither Quick Nor Simple
If a buyer defaults on a seller-financed note, getting the property back means foreclosure—the same process banks use. The timeline and cost depend heavily on state law.
In judicial foreclosure states like New York, New Jersey, Florida, Illinois, Ohio, and Pennsylvania, the seller must go through the court system. This typically takes 12 to 36 months from default to completed sale. Legal fees range from $10,000 to over $50,000.
In non-judicial foreclosure states like Texas, Georgia, Arizona, and California, sellers can use a trustee sale process that typically takes 3 to 6 months. Legal fees range from $3,000 to $15,000. But strict notice requirements must be followed. Mistakes can restart the timeline.
During this period, the property may be abandoned or neglected. The seller often faces preservation costs—securing, winterizing, and maintaining the property—while receiving no payments.
If the buyer files for bankruptcy, an automatic stay halts foreclosure proceedings. This can add 6 to 18 months to the recovery timeline.
Servicing Is an Ongoing Burden
And while waiting for recovery, the seller's administrative obligations don't pause.
Carrying a note creates administrative responsibilities that persist for the life of the loan. Under CFPB mortgage servicing rules, note holders must send monthly statements, accept and record payments, manage escrow accounts for taxes and insurance, track delinquencies, and maintain compliance records. This isn't optional—it's legally required.
Sellers can outsource this work to professional loan servicers. Servicing typically costs $15 to $50 per month depending on services and note size. But outsourcing transfers the work, not the responsibility. The seller remains liable for compliance failures.
Self-servicing saves money but creates ongoing work. Missing statements, misapplied payments, or documentation gaps create legal exposure. This burden continues for years—potentially decades if the note has a long term.
Tax Treatment
Tax Treatment Has Two Components
Seller financing creates two separate tax obligations that operate differently.
IRS Publication 537 governs installment sales. When a seller carries financing, gain isn't taxed all at once—it's reported proportionally as payments are received. Each payment contains three components: return of basis (not taxed), capital gain (taxed at capital gains rates), and interest (taxed separately).
The interest component is the surprise. Interest received on seller-financed notes is taxed as ordinary income, not capital gains. For sellers in higher tax brackets, this can create significantly higher tax liability than expected on the interest portion.
The installment method has limitations. It cannot be used for sales at a loss. Related party sales face additional restrictions. And the choice to use installment reporting is often difficult to reverse once made.
Tax treatment of seller financing involves specific IRS rules. Consult a tax professional for advice on your situation.
Land Contracts: State-by-State Reality
For sellers considering land contracts specifically, state law creates the most significant variable.
Land Contract Rules Vary Dramatically by State
Land contracts are not treated the same way in every state. In some states, they work as sellers expect. In others, they're heavily restricted or effectively impossible.
Texas essentially eliminated traditional land contracts in 2005. The Texas Property Code (Sections 5.061-5.085) now requires either deed delivery within 30 days or conversion to a recorded executory contract with extensive buyer protections. Violations can result in contract voidability and penalties to the seller.
Ohio requires land contracts to be recorded. More significantly, Ohio Revised Code Section 5313 limits forfeiture rights once buyers have paid 20% of the purchase price or made payments for 5 years. After these thresholds, sellers must use foreclosure rather than forfeiture.
Minnesota requires recording and gives buyers redemption rights similar to mortgage foreclosure. Cancellation requires at least 60 days' notice.
Before considering a land contract, sellers need to know their state's specific rules. What works in one state may be illegal or heavily restricted in another.
State laws governing land contracts vary significantly. Consult a local real estate attorney for jurisdiction-specific guidance.
Forfeiture Rights Often Convert to Foreclosure
Even in states where land contracts are legal, the assumed advantages may not hold.
One advantage sellers associate with land contracts is forfeiture—the ability to cancel the contract and retake possession without foreclosure. But many states limit or eliminate this advantage once buyers build up equity.
Michigan Compiled Laws Section 600.5726 illustrates this. When less than 50% of the contract is paid, sellers can use a 90-day forfeiture notice. But once the buyer has paid more than 50%, forfeiture is no longer available. The seller must use judicial foreclosure—the same process required for traditional seller financing.
Ohio's threshold is lower: 20% paid or 5 years of payments triggers the same conversion. A seller who entered a land contract expecting quick forfeiture on default may find themselves facing a 12-36 month judicial foreclosure instead.
The "simple forfeiture" benefit often exists only in early years when buyer default is less likely. By the time significant equity builds up—when default becomes more consequential—the forfeiture option may have disappeared.
Wraparounds: Hidden Risks
Wraparound mortgages carry risks that don't exist in traditional seller financing or land contracts.
Due-on-Sale Clauses Apply to Wraparounds
Most residential mortgages contain due-on-sale clauses. When a property transfers, the lender can demand immediate payment of the full loan balance. This applies to wraparound arrangements.
The Garn-St. Germain Act of 1982 (12 USC 1701j-3) upheld the enforceability of these clauses. Courts have consistently ruled that lenders can call loans due when they discover transfers, including wraps—even when payments are current.
Lenders may discover wraps through several channels: payment pattern changes, insurance policy inquiries, property tax record reviews, or routine loan portfolio audits. Discovery doesn't always trigger acceleration, but lenders have the contractual right to demand full payment.
Enforcement is more common when interest rates are rising. If the existing loan carries a rate below current market rates, lenders have financial incentive to call the loan and force refinancing at higher rates.
Some sellers proceed with wraps despite this risk. But the due-on-sale clause means the original lender keeps the power to unwind the arrangement by demanding full payment.
Due-on-sale enforcement involves legal rights under federal law and loan documents. Consult a real estate attorney for specific guidance.
Payment Gap Risk Can Trigger Foreclosure Despite Current Payments
Beyond due-on-sale, wraparounds create a second structural vulnerability.
In a wrap, the buyer pays the seller, and the seller is supposed to pay the underlying loan. But these are separate obligations. If the seller receives the wrap payment but doesn't pay the underlying loan, the original lender will initiate foreclosure—on the seller.
The buyer can be completely current on wrap payments while the seller faces foreclosure from the original lender. The buyer may not know about the default until foreclosure proceedings are underway.
Third-party servicing can reduce this risk by ensuring underlying payments are made directly from collected wrap payments. But it cannot eliminate the risk entirely—it depends on the wrap payment being sufficient and the servicer being reliable.
The seller's financial difficulties, not the buyer's payment behavior, can collapse the arrangement.
Regulatory Requirements
Dodd-Frank Rules Apply to Most Seller Financing
Federal law regulates seller financing. The Dodd-Frank Act requires seller-financiers to verify the buyer's ability to repay—unless they qualify for exemptions.
Two exemptions cover most individual sellers:
The 3-property exemption: Natural persons who provide financing on 3 or fewer properties in any 12-month period are exempt from licensing requirements if the loan is fully amortizing (no balloon payments or negative amortization).
The principal residence exemption: Sellers financing the sale of their own principal residence can provide one seller-financed sale per 12-month period without complying with ability-to-repay requirements.
Sellers who exceed these limits face Dodd-Frank's ability-to-repay requirements. They must document and verify the buyer's income, assets, employment, and debts—the same process mortgage lenders use.
Non-compliant loans may be unenforceable. A seller who finances a fourth property without compliance could find the note challenged in court if the buyer later defaults.
Dodd-Frank compliance involves federal regulations. Consult an attorney familiar with CFPB rules for specific guidance.
Understanding the Full Picture
Three Different Structures, Three Different Risk Profiles
"Seller financing" isn't one thing. It's three fundamentally different structures that share only the characteristic that the seller receives payments over time.
Traditional seller financing transfers title and gives the seller a lien—essentially the position a bank holds. Recovery on default means foreclosure: months to years, thousands in legal fees, and uncertain outcome.
Land contracts keep title with the seller but vary dramatically by state. Texas effectively banned them. Ohio and Michigan convert forfeiture rights to foreclosure requirements once buyers build equity. The "simple forfeiture" advantage may not exist in your state or your situation.
Wraparounds transfer title while keeping the underlying loan in place. Due-on-sale risk and payment gap risk create exposure that doesn't exist in other structures. The original lender keeps power over an arrangement they never approved.
Each structure carries servicing burden, tax complexity, and regulatory requirements. Interest is ordinary income, not capital gains. Dodd-Frank applies unless exemptions fit.
The question isn't whether seller financing is good or bad. It's which of three structures is being proposed, whether that structure works in your state, and whether the mechanics match what you expect.
Understanding the differences is the foundation for evaluating any seller financing offer.
Related Pages
Situations where this structure applies:
Related structures:
Loan Assumption — buyer takes over your loan directly
Lease-Option — tenant with purchase option
Go deeper:
Disclaimer: This page provides general educational information about seller financing structures. It does not constitute legal, tax, or financial advice. Seller financing involves complex legal and regulatory requirements that vary by state. Consult qualified professionals—including a real estate attorney and tax advisor—before entering into any seller financing arrangement.
For help evaluating a specific offer, see Red Flags and Warning Signs and Questions to Ask Before Signing.
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