Seller Financing

When someone offers to buy your home with seller financing—where you provide the loan instead of a bank—you might focus on one question: will they make the payments? That's important, but it's not the only thing that matters.

This page explains what seller financing actually involves and what you need to understand before agreeing to finance a sale.

You Become the Lender

When you offer seller financing, you're not just selling a house—you're becoming a lender. The promissory note the buyer signs creates a legal obligation to pay you back, but that obligation doesn't enforce itself. If they stop paying, you'll need to take legal action to recover.

Here's the key difference between you and a bank: a bank spreads its risk across thousands of loans. If one borrower defaults, it's a small percentage of their portfolio. Your entire exposure is concentrated on this one borrower and this one property. That's not "like being the bank"—it's riskier than being the bank.

Understanding that you're taking on a lender's role means understanding what happens when borrowers don't pay.

Foreclosure Takes Longer and Costs More Than You Think

If your buyer stops paying, getting the property back isn't quick or simple. Foreclosure follows the same legal process whether the lender is a bank or a homeowner—and that process takes time.

In states that require judicial foreclosure (where a judge oversees the process), you're typically looking at 6 to 18 months from default to recovery. Non-judicial foreclosure states are faster—3 to 6 months—but even that's not quick.

Then there's cost. Legal fees for foreclosure typically run $3,000 to $15,000, depending on complexity and whether the borrower contests it. Add filing fees, service of process costs, and potentially auction expenses.

During this entire period, you're receiving no payments from the defaulting buyer. But you may still need to cover property taxes, insurance, and HOA dues to protect your collateral interest. The meter is running while you wait.

Foreclosure timelines and costs vary by state. Research your state's specific rules.

The timeline matters because of what can happen to the property during that period.

What Happens While You Wait

During those months of foreclosure, you're not just missing payments—you may be watching your collateral deteriorate.

Borrowers who can't make mortgage payments usually can't afford maintenance either. Deferred repairs accumulate. In climates with harsh winters or humid summers, a few months of neglect can cause serious damage.

Here's the frustrating part: you no longer own the property. You have no legal right to enter and inspect without the borrower's consent. You won't necessarily know about that leaking roof or broken HVAC until you finally recover the property.

There's also the risk of accumulating liens. If the borrower lets code violations pile up, municipal fines can become liens against the property—liens that in some jurisdictions are senior to your mortgage. By the time you foreclose, your collateral may be worth significantly less than what you're owed.

Dodd-Frank Applies to You

Many sellers assume they can structure a private financing deal however they want. That's not entirely true. The Dodd-Frank Act's Ability-to-Repay rules apply to seller-financed transactions, with penalties for violations.

There are exemptions, but they have conditions.

The one-property exemption lets you finance one property per year without complying with all the rules, but you must meet certain requirements. The most notable: no balloon payment due before 5 years. If you want the buyer to pay off or refinance in 3 years with a balloon payment, you may not qualify for this exemption.

A three-property exemption allows more transactions per year, but adds more conditions: fixed interest rate (or adjustable only after 5+ years), no use of mortgage brokers, and others.

Violating Dodd-Frank's seller financing rules can expose you to liability. The borrower may have legal claims against you. Before finalizing any deal structure, understand which exemption applies—if any—and what conditions it requires.

This is general information about federal regulations. Consult an attorney for compliance advice specific to your situation.

Regulatory compliance is one ongoing responsibility. Servicing the loan is another.

The Work of Being a Lender

Seller financing isn't passive income. Someone has to do the work of loan servicing—either you or a third party you pay.

Servicing means: collecting monthly payments, keeping accurate records, managing escrow accounts if you're collecting for taxes and insurance, providing annual statements to the borrower, and reporting to the IRS via Form 1098 showing interest paid.

If you self-service, you're responsible for all of this. Many sellers underestimate the record-keeping burden until tax time, when they realize they need to issue a 1098 and their records aren't adequate.

Professional note servicers handle these tasks for you, but they charge for it—typically 0.25% to 0.5% of the loan balance annually, plus setup fees. On a $200,000 note, that's $500 to $1,000 per year in servicing costs.

Either you do the work, or you pay someone to do it. The "passive" income from seller financing has ongoing overhead.

Then there's tax treatment, which is more complex than simply receiving payments.

Tax Treatment Is More Complex Than You Think

Seller financing triggers installment sale tax treatment, which sounds good (defer some taxes!) but creates complexity.

Each payment you receive is split two ways for tax purposes. The interest portion is taxed as ordinary income—your regular tax rate. The principal portion includes some capital gain, calculated using your "gross profit ratio" from the original sale.

You'll need to track these allocations for every payment, every year. Or pay an accountant to do it.

Here's a wrinkle many sellers don't anticipate: if the buyer defaults and you repossess the property, you may face gain recognition under IRC § 1038. That can mean owing taxes even when you're taking back an asset that's worth less than what the buyer owed you. Default doesn't just cost you foreclosure fees—it can create a tax bill.

The tax deferral benefits of seller financing are real, but so is the complexity. This isn't something to figure out at tax time.

Tax treatment depends on your specific situation. Consult a tax professional before structuring a seller-financed transaction.

You're Not a Bank

When banks make loans, they require extensive documentation: income verification, credit checks, property appraisals, and often mortgage insurance on high loan-to-value loans. They do this because they understand risk.

Seller financing typically skips most of these safeguards. The appeal is often that it works when conventional financing doesn't—which usually means the buyer couldn't meet a bank's standards.

There's nothing inherently wrong with that. Self-employed borrowers with strong income may have trouble documenting it. But understand what you're accepting: more risk, with fewer protections, concentrated entirely on one borrower.

When things go wrong, you face a triple impact. First, you lose the income stream—no more payments. Second, you spend thousands on foreclosure. Third, you may recover a property that's now worth less than what you're owed, damaged by neglect during the default period.

Banks absorb this across thousands of loans. You absorb it all at once.

Here's how all these factors can come together.

How This Can Play Out

Consider this scenario.

A seller finances a $200,000 sale with 10% down and a 6% interest rate over 30 years. The buyer makes payments reliably for three years.

Then they stop.

The seller is in a judicial foreclosure state. After attempts to work with the buyer fail, the seller hires an attorney. Fourteen months and $8,000 in legal fees later, the seller finally recovers the property.

During those 14 months, the buyer—unable to pay—also neglected maintenance. The roof leaked, causing water damage. The HVAC failed and wasn't repaired. Code violations accumulated. The property now needs $25,000 in repairs and is worth about $180,000.

The seller spent over a year in litigation, paid $8,000 in legal fees, and recovered an asset worth less than what they were owed—all while receiving no payments and likely covering property taxes and insurance to protect their lien position.

This is what default looks like.

The Full Picture

Seller financing means becoming a lender. That's not a metaphor—it's a legal and operational reality.

As a lender, you take on responsibilities banks handle: servicing the loan, ensuring compliance with regulations, managing tax reporting, and potentially enforcing through foreclosure. You also take on risks banks mitigate through diversification and rigorous underwriting.

Payment risk is real—the risk that your borrower stops paying is the most obvious concern. But it's not the only risk, and not the only cost.

There's regulatory compliance. Dodd-Frank applies, with conditions you may or may not meet.

There's servicing burden. Either you do the work or you pay someone.

There's tax complexity. Installment sale treatment creates ongoing obligations and potential surprises if the buyer defaults.

There's enforcement cost. Foreclosure takes months to years and costs thousands.

There's property preservation risk. You have limited control over a property you no longer own.

Seller financing can serve legitimate goals: deferring taxes, creating income streams, selling properties that are hard to finance conventionally. But the income stream has overhead. Understanding all the dimensions—not just "will they pay?"—is how you make an informed decision.