To owner finance a house, you sell the property directly to the buyer, take a down payment, and hold a private mortgage for the balance, collecting monthly payments with interest until a balloon date or full payoff. The deal works when three things are handled correctly: the loan is structured to fit a federal exemption from loan-originator rules, any existing mortgage on your property is cleared or accounted for, and the promissory note and security instrument are drafted so you can actually enforce them. Everything else is detail on top of those three.
How the Loan Is Structured
The purchase price anchors everything. Most sellers start with a formal appraisal or a comparative market analysis to establish a defensible number. From there the buyer puts down a lump sum and you finance the rest. Down payments on owner-financed deals typically run between 10% and 20% of the price, which gives the buyer immediate equity and gives you a cushion against default.
Interest rates on these private loans generally run higher than a bank would charge, often between 6% and 10%. The rate reflects the extra risk you take on by skipping institutional underwriting. There is a floor, though: the IRS requires the rate to meet or exceed the Applicable Federal Rate for the month you close, discussed below.
Monthly payments are usually calculated on a 30-year amortization schedule to keep them affordable, but the loan itself rarely lasts that long. Most seller-financed deals include a balloon payment due in five to ten years, at which point the buyer must pay off the remaining balance. That gives the buyer a window to improve credit or build equity and then refinance into a conventional mortgage. If they can’t refinance when the balloon hits, you may agree to extend, but nothing obligates you to.
Clearing the Due-on-Sale Clause on Your Existing Mortgage
If you still owe a mortgage on the property, address this before anything else. Nearly every residential mortgage contains a due-on-sale clause that lets the lender demand the full remaining balance the moment you transfer ownership or any interest in the property. Federal law explicitly authorizes lenders to enforce these clauses and preempts state laws that try to restrict them.1eCFR. 12 CFR Part 191 – Preemption of State Due-on-Sale Laws
Selling on owner financing while your bank loan is still in place means the lender can discover the transfer, call the balance, and foreclose if you can’t pay. The buyer is then living in a house being foreclosed on by a bank they have no relationship with.
The Garn-St. Germain Act protects a narrow set of transfers, including transfers to a spouse or child, transfers on the borrower’s death, and transfers into a trust where the borrower remains a beneficiary.2Office of the Law Revision Counsel. 12 USC 1701j-3 – Preemption of Due-on-Sale Prohibitions An ordinary owner-financed sale to an unrelated buyer is not among them. The cleanest fix is to pay off the existing mortgage at closing from the buyer’s down payment plus other funds, or to refinance to a payoff position before you sell.
Fitting a Dodd-Frank Exemption
The Dodd-Frank Act treats anyone who finances a home sale as a potential loan originator, which would trigger licensing and disclosure requirements most private sellers can’t meet. Regulation Z carves out two exemptions that keep most one-off sellers out of that net. Which one applies depends on how many properties you finance in a year and how you structure the loan.
The One-Property Exemption
If you are a natural person (not a company), finance the sale of only one property in any 12-month period, own the property, and did not build the home, you are not treated as a loan originator. The loan cannot produce negative amortization and must carry either a fixed rate or an adjustable rate that doesn’t reset for at least five years with reasonable caps on rate increases. Balloon payments are allowed under this exemption, and you are not required to formally verify the buyer’s ability to repay.3eCFR. 12 CFR 1026.36 – Prohibited Acts or Practices and Certain Requirements for Credit Secured by a Dwelling
The Three-Property Exemption
Sellers financing up to three properties in a 12-month period can also avoid loan originator status, but the rules tighten. The loan must be fully amortizing with no balloon at all. The rate must be fixed or adjustable with a minimum five-year initial period and reasonable caps. And you must make a good-faith determination that the buyer can afford the payments. You don’t have to run full bank-style underwriting, but keep records of how you reached that conclusion.3eCFR. 12 CFR 1026.36 – Prohibited Acts or Practices and Certain Requirements for Credit Secured by a Dwelling
Finance more than three properties in a year, or write a loan that doesn’t meet either structural test, and you are a loan originator under federal law and must comply with the full range of lending regulations, including licensing. That’s territory where you need a real estate attorney, not a template.
Setting the Interest Rate Above the AFR
You and the buyer can negotiate whatever interest rate you want, but the IRS sets a minimum. If the rate in your agreement falls below the Applicable Federal Rate for the month the deal closes, the IRS will recharacterize part of each payment as imputed interest, taxing you on income you didn’t actually collect as interest. The AFR varies by loan length and is published monthly.4Internal Revenue Service. Applicable Federal Rates
For January 2026, the long-term AFR (used for obligations over nine years, which covers most owner-financed deals) is 4.63% with annual compounding. The mid-term rate is 3.81% and the short-term rate is 3.63%. Since most owner-financed arrangements carry rates well above these figures, the AFR floor rarely forces a change. If you’re offering a below-market rate as a favor to a family member or to sweeten a deal, check the current month’s rates before finalizing the note. Charging even a fraction below the AFR creates a tax problem that’s entirely avoidable.5Internal Revenue Service. Revenue Ruling 2026-2 – Applicable Federal Rates for January 2026
Vetting the Buyer
Banks spend weeks underwriting borrowers. Do your own version of that. Start with a credit report, looking for patterns rather than perfection: a buyer turned down for a thin credit file is different from one with multiple recent defaults.
Verify income through tax returns or pay stubs and calculate the buyer’s debt-to-income ratio. If total monthly debt obligations, including the proposed payment to you, exceed roughly 43% of gross monthly income, the buyer is stretching. That doesn’t automatically kill the deal, but it argues for a larger down payment or a shorter term.
Request recent bank statements showing enough liquid cash to cover the down payment and closing costs without draining every account. Check for outstanding judgments or liens that could compete with your security interest. Under the three-property exemption, this due diligence isn’t just prudent; the regulation requires a good-faith ability-to-repay determination.3eCFR. 12 CFR 1026.36 – Prohibited Acts or Practices and Certain Requirements for Credit Secured by a Dwelling
The Two Documents That Make the Deal Enforceable
Two documents form the backbone of every owner-financed deal: the promissory note and the security instrument. They serve different functions and both must be drafted correctly. Use a real estate attorney for this step even if you handle every other part of the deal yourself. A badly drafted note or deed of trust is the kind of mistake you only see once you’re in a dispute.
The Promissory Note
The promissory note is a written, signed promise by the buyer to repay a specific amount on specific terms. It names borrower and lender, states the principal, sets the interest rate, and lays out the payment schedule including due dates, payment amounts, and where payments are sent. If you’ve included a balloon, the note specifies the exact date it comes due and the expected amount.
The note should contain an acceleration clause stating that the full balance becomes due immediately on missed payments or other default. Without this clause, a default only entitles you to collect the missed payments, not to call the loan. Late fees should be spelled out too, typically a percentage of the monthly payment that kicks in after a short grace period.
The Security Instrument
The note creates the debt. The security instrument ties that debt to the property, giving you the right to foreclose if the buyer stops paying. Depending on your state, this will be a mortgage or a deed of trust. The practical difference is that a deed of trust involves a neutral trustee who can conduct a foreclosure sale without going through court, while a mortgage typically requires a judicial foreclosure with court oversight.
The security instrument must include the exact legal description of the property, copied from the current deed or obtained from the county recorder’s office, and its payment terms must match the promissory note exactly. Any discrepancy between the two documents creates an opening for the buyer to challenge enforcement. The instrument should also require the buyer to maintain homeowners insurance and stay current on property taxes, since both protect the collateral securing your loan.6Consumer Financial Protection Bureau. Deed of Trust / Mortgage Explainer
Title Insurance, Closing, and Recording
In a traditional sale, the bank requires a lender’s title policy before funding. In an owner-financed deal, nobody requires anything unless you build it into the agreement. The buyer should get an owner’s title policy protecting against claims from before the sale, such as undisclosed liens, boundary disputes, or chain-of-title errors. You, now acting as the lender, should seriously consider a separate lender’s policy covering the financed amount. If the buyer defaults and you foreclose, a title defect that surfaces then could wipe out your recovery. Both policies are one-time purchases paid at closing.
At closing, a notary public witnesses and notarizes signatures on the note and security instrument so they are enforceable and eligible for recording. The buyer delivers the down payment, typically by cashier’s check or wire.
Filing the security instrument with the county recorder’s office (in some jurisdictions the registrar of deeds) is what protects your lien. Recording creates a public record establishing your priority over anyone who later tries to place a claim against the property. Skip recording and a subsequent creditor, or even a fraudulent second sale, could take priority over your interest. Recording fees vary but are modest. Once the instrument is recorded, the payment schedule begins on the date specified in the note. The buyer is the homeowner and you are the lender.
Collecting Payments and Protecting the Collateral
Collecting monthly payments yourself is technically simple but creates bookkeeping obligations. Every payment needs to be tracked, split correctly between principal and interest, and documented for tax purposes. Late payments require notices and fee calculations.
Many sellers hire a third-party loan servicer. A professional servicer collects payments, maintains amortization records, sends late notices, and issues year-end tax forms to both parties. A neutral third party also spares you the awkwardness of chasing a buyer personally, which can poison the relationship before any real dispute begins.
Property taxes and homeowners insurance are the other ongoing concern. If the buyer stops paying property taxes, a tax lien could take priority over your mortgage lien. If insurance lapses and the house burns down, your collateral is gone. Some sellers build an escrow into the payment, collecting an extra monthly amount on top of principal and interest and paying the tax and insurance bills directly. Others simply require the buyer to provide proof of current payments on a regular schedule. Either way, the security instrument should explicitly obligate the buyer to keep both current.
How You’ll Be Taxed on the Sale
The IRS treats an owner-financed sale as an installment sale, so you don’t pay tax on the full gain in the year you sell. You report a portion of each payment as gain, spreading the tax across the years you receive payments.7Office of the Law Revision Counsel. 26 USC 453 – Installment Method
The math runs through a gross profit percentage. Divide your total profit on the sale (selling price minus your adjusted basis and selling expenses) by the contract price. That percentage is applied to each principal payment you receive during the year to determine how much is taxable gain. Interest you receive is reported separately as ordinary income.8Internal Revenue Service. Publication 537 – Installment Sales
Report this income on Form 6252, filed with your return in the year of sale and every subsequent year you receive payments.9Internal Revenue Service. About Form 6252 – Installment Sale Income One wrinkle catches people off guard: if the property is depreciable, as with a rental converted to a sale, any depreciation recapture must be reported as ordinary income in the year of sale even if you haven’t received enough cash to cover that tax.10Internal Revenue Service. Topic No. 705 – Installment Sales
If your rate falls below the AFR, the IRS recharacterizes part of each principal payment as unstated interest, shifting income between categories and often increasing your tax bill even though total dollars don’t change. Charging at or above the AFR avoids this.10Internal Revenue Service. Topic No. 705 – Installment Sales
If the Buyer Stops Paying
Default is the risk that keeps seller-financers up at night, and the remedy depends on the security instrument and your state’s law. Generally you have two paths: take the property back through foreclosure, or sue the buyer for the money owed.
With a deed of trust, most states allow a non-judicial foreclosure handled by the trustee. It moves faster and costs less because no lawsuit is required. It involves a series of notices, mandatory waiting periods, and a public auction, and typically takes a few months from start to finish.
With a mortgage, most states require judicial foreclosure: filing a lawsuit, working through the court system, and waiting for a judge to authorize the sale. This can take several months to well over a year, and the buyer may have a redemption period after the sale during which they can reclaim the property by paying the full debt.
The acceleration clause in your promissory note is what makes the full balance due on default rather than just the missed payments. Without it, you’d have to sue for each individual missed payment, which is as impractical as it sounds. It reads like boilerplate until you need it, and then it’s the most important sentence in the agreement.