To set up a seller financing deal, you agree on the price and repayment terms with the buyer, confirm the structure fits within a Dodd-Frank exemption for individual sellers, check whether your existing mortgage has a due-on-sale clause, draft a promissory note along with a security instrument and purchase agreement, and then close, notarize, and record the security instrument with the county. The seller takes the role the bank would normally play, carrying a note secured by the property. Getting each step right protects the lien and keeps the loan enforceable; getting them wrong can hand a defaulting buyer a defense in foreclosure or trigger acceleration of your own mortgage.
Agree on the Four Financial Terms
Every seller-financed deal is built on four numbers: the purchase price, the down payment, the interest rate, and the loan term. Down payments typically fall between 10% and 20% of the price, and a bigger one lowers your risk because the buyer has more to lose by walking away.
Interest rates on seller-financed notes usually run higher than conventional mortgage rates, often 6% to 10%, depending on the buyer’s credit and the down payment. You cannot set the rate at whatever you like. Federal tax law sets a floor, and some states cap the ceiling. Late fees generally run about 4% to 5% of the overdue installment, subject to state limits.
Using the principal and rate, build an amortization schedule that shows how each payment splits between principal and interest. Many seller-financed deals stretch amortization over 30 years to keep the monthly payment low, then require the buyer to pay off the remaining balance in a lump sum after five to ten years. That lump sum is a balloon payment, and whether you are allowed to include one depends on the Dodd-Frank exemption you qualify for.
Confirm You Qualify for a Dodd-Frank Exemption
The Dodd-Frank Act treats anyone offering a mortgage loan as a “loan originator” subject to federal consumer protection rules. Two narrow exemptions exist for individual sellers, and which one applies decides what loan structures are legal and how much due diligence you owe the buyer.
The One-Property Exemption
If you are a natural person, estate, or trust, and you seller-finance only one property in any 12-month period, you get the lighter treatment. The loan cannot result in negative amortization. The interest rate must be fixed, or if adjustable, cannot adjust for at least five years. Balloon payments are allowed. You are not formally required to verify the buyer’s ability to repay, though doing it anyway protects your investment.
The Three-Property Exemption
If you finance two or three properties in any 12-month period, the rules tighten. The loan must be fully amortizing, so no balloon at all. You must make a good-faith determination that the buyer can afford the payments, and you have to verify the information with reasonably reliable records rather than take the buyer’s word. The same interest-rate rule applies. You also cannot have built the home as a contractor or developer.
Both exemptions share one boundary: if you built the residence in the ordinary course of your business, neither exemption applies, and you fall under the full ability-to-repay framework with all eight CFPB underwriting factors. Financing more than three properties in a 12-month period lands you in the same place.
This is not a paperwork technicality. A buyer who later defaults can use a Dodd-Frank violation as a defense in foreclosure, arguing the loan was illegal from the start. If you want a balloon in the deal, confirm you qualify under the one-property exemption before you draft the note.
Meet the IRS Minimum Interest Rate
The IRS requires private loans to charge at least the applicable federal rate, or AFR, which the Treasury publishes monthly. Charge less than the AFR and the IRS imputes interest at the federal rate anyway, taxing both parties as though the higher rate applied.
Which AFR you use depends on the loan term: short-term for three years or less, mid-term for terms over three and up to nine years, and long-term for anything over nine years. Most seller-financed deals run well beyond nine years, so the long-term AFR is the relevant floor. Rates change every month, so check the IRS revenue ruling for the month the deal closes. You can also use the lowest AFR from the three-month window ending with the month of the binding written contract, which gives you a small chance to lock in a better rate.
In most arm’s-length deals the rule never bites, because market rates on seller-financed notes sit well above the AFR. It matters most when you are financing a sale to a family member and thinking about charging minimal interest as a favor. The imputed-interest rules treat the forgone interest as a taxable gift from lender to borrower, plus phantom interest income back to the lender.
Vet the Buyer’s Finances
Even when the one-property exemption does not legally require it, skipping this step is one of the fastest routes to a foreclosure six months later. Ask for the buyer’s recent credit report, two years of tax returns, current pay stubs (or profit-and-loss statements if they are self-employed), and two to three months of bank statements.
Calculate a rough debt-to-income ratio by dividing total monthly debt obligations, including the proposed payment to you, by gross monthly income. Conventional lenders generally want that number under 43%. You have room to be more flexible, but anything above 50% is a serious warning sign.
If you fall under the three-property exemption, the good-faith ability-to-repay determination is not optional, and verification through reliable records is part of it.
Check Your Existing Mortgage for a Due-on-Sale Clause
Before agreeing to finance anything, check whether your own mortgage on the property has a due-on-sale clause. Most conventional residential loans do. The clause gives your lender the right to demand full repayment of the remaining balance the moment you transfer any interest in the property. Seller financing can trigger it, and enforcement means an acceleration notice giving you roughly 30 days to pay off the loan or face foreclosure.
Standard Fannie Mae and Freddie Mac uniform mortgage instruments include a due-on-sale clause, typically in Paragraph 18. If your loan uses one of those forms, assume the clause is there.
The Garn-St. Germain Depository Institutions Act lists transfers on residential property of fewer than five units that lenders cannot use to accelerate: transfers on death of a borrower, transfers to a spouse or children, transfers through divorce or separation, transfers into a living trust where the borrower stays a beneficiary with occupancy rights, subordinate liens that do not shift occupancy, and leases of three years or less without a purchase option. A straight sale to an unrelated buyer with seller financing is not on that list. The lender can legally accelerate.
Some sellers proceed anyway and bet the lender will not notice as long as payments arrive on time. That bet sometimes works and sometimes blows up on both parties. The safer paths are to pay off the existing mortgage at closing out of the down payment and other funds, ask the lender for a written waiver, or confirm the loan is fully assumable.
Draft the Three Core Documents
Three documents form the backbone of the transaction. Title-company templates can work for straightforward deals, but a real estate attorney should draft or at least review them for your specific terms.
The Promissory Note
The promissory note is the buyer’s written promise to repay. It states the principal amount, the interest rate (written as both a number and words to prevent disputes), the monthly payment, payment due dates, and late-fee terms. It also defines what counts as a default and what the seller can do in response, including accelerating the entire remaining balance.
If the loan includes a balloon payment, the note must state the balloon date and the approximate amount coming due. Spelling it out in plain terms cuts off the later argument that the buyer did not understand a balloon was coming.
The Security Instrument
The security instrument ties the debt to the property. Depending on your state, it takes the form of a mortgage or a deed of trust. Both give the seller the right to foreclose if the buyer stops paying. The difference is procedural. Deed-of-trust states generally allow non-judicial foreclosure through a power-of-sale process, which is faster. Mortgage states usually require judicial foreclosure through the court system, which is slower but may preserve the right to a deficiency judgment if the sale does not cover the full debt.
The security instrument must include the property’s legal description, copied exactly from the current deed. That is the technical identifier using metes and bounds, lot and block, or another local system. A mistake here can make the lien unenforceable, so verify every word against the recorded deed.
The Purchase Agreement
The purchase agreement is the overarching sales contract. It should include a financing contingency stating that the sale depends on both parties executing the promissory note and security instrument on the agreed terms, and it should restate the key financial terms so there is no ambiguity about what will appear in the note. It also covers the usual real estate contract items: closing date, allocation of closing costs, inspections, and dispute resolution.
Order Title Work and Lender’s Title Insurance
Before closing, run a title search to confirm clear ownership and flag any liens, judgments, or encumbrances that could take priority over the buyer’s new lien. A title company or real estate attorney handles this.
As the seller-lender, get a lender’s title insurance policy. It protects your financial interest if a title defect surfaces after closing, such as a previously unknown heir claiming ownership or an old contractor’s lien that was never released. Without it, a defect that voids your lien could leave you with an unsecured debt and no practical remedy. The buyer typically pays for the lender’s policy at closing, but that is negotiable.
Require Hazard Insurance and Handle Property Taxes
The property is your collateral. If it burns or the county seizes it for unpaid taxes, your security disappears. Two provisions in the loan documents keep that from happening.
Require the buyer to carry a homeowner’s insurance policy with a standard mortgagee clause (sometimes called a “New York” clause) naming you as loss payee. The insurer must notify you before canceling and must pay you directly from claim proceeds up to your outstanding balance. If the buyer lets the policy lapse, the clause typically lets you pay the premium and add the cost to the loan balance. Include the notation “ISAOA/ATIMA” (its successors and/or assigns, as their interests may appear) so your rights transfer if you later sell the note.
Unpaid property taxes create a lien that in most jurisdictions takes priority over your mortgage lien. The cleanest fix is to collect a monthly escrow amount on top of principal and interest and pay the tax bills yourself from that account. It adds bookkeeping, but it keeps the taxes current. A third-party loan servicing company can handle the escrow for a modest monthly fee.
Close, Notarize, and Record
At closing, both parties sign the promissory note, security instrument, and purchase agreement in front of a notary public. The notary verifies each signer’s identity and witnesses the signatures. Notaries do not review documents for legal accuracy, so notarization is not a substitute for having an attorney look at the papers.
After signing, record the security instrument with the county recorder or registrar of titles in the county where the property sits. Recording puts the world on notice that you hold a lien. It prevents the buyer from selling the property or borrowing against it without satisfying your debt first, and it fixes your priority relative to any later liens. Recording fees vary but generally run about $50 to $150 depending on page count and local schedules. Processing usually takes one to four weeks, and the county returns the original document with a recording stamp.
Do not delay recording. An unrecorded lien is invisible. If the buyer sells to a third party who has no knowledge of your loan, you can lose your security interest entirely.
Many sellers hire a loan servicing company to collect monthly payments, send year-end tax statements, and manage escrow. Fees for private-note servicing typically run $25 to $35 a month with a small setup charge. The paper trail protects both parties and makes the note easier to sell later if you want to cash out.
Report the Sale Correctly on Your Taxes
The IRS treats most seller-financed real estate sales as installment sales under Internal Revenue Code Section 453. Instead of reporting the whole gain in the year of sale, you spread it over the years you receive payments. Each payment you receive breaks into three parts: a return of your original basis (not taxed), gain on the sale (taxed as capital gain), and interest income (taxed as ordinary income).
To find the taxable gain portion of each payment, you calculate a gross profit percentage (total gain divided by the contract price) and apply it to each year’s principal payments. Interest gets reported separately. IRS Publication 537 walks through the full calculation.
File IRS Form 6252 for the year of sale and every year afterward that the installment obligation is still outstanding, even years when you receive no payment. If you sold to a related party (spouse, child, sibling, or a controlled entity), Form 6252 Part III must also be completed for the year of sale and the two following years.
Buyers claiming the mortgage interest deduction usually expect a Form 1098. If you sold your former personal residence and are collecting payments as an individual, you generally do not have to issue Form 1098 because you are not receiving the interest as part of a trade or business. If you provide financing as part of a business (developer, flipper, or similar), you must file Form 1098 for each borrower who pays you $600 or more in mortgage interest during the calendar year. Even when Form 1098 is not required, the buyer can still deduct qualified mortgage interest and simply reports it differently.
Keep clean records of every payment, split between principal and interest. A loan servicing company handles the accounting and generates the year-end statements automatically, which is often worth the fee on its own.