In real estate, carrying the note means the seller finances the sale instead of a bank. The buyer signs a promissory note promising to repay a set amount at an agreed interest rate, gives the seller a recorded lien on the property as collateral, and makes monthly payments directly to the seller over the loan’s term. The arrangement also goes by seller financing, owner financing, or a seller take-back mortgage, but the structure is the same: the seller holds the buyer’s promise to pay and earns interest on the balance until it is paid off.
How the Deal Is Structured
Price, down payment, interest rate, and repayment schedule are all negotiated between the two parties. What differs from a bank sale is who writes the check at closing and who collects payments afterward. The seller does both.
Two structures dominate, and they split on who holds the deed during repayment.
Under a note and mortgage (or deed of trust), the seller transfers the deed to the buyer at closing. The buyer signs a promissory note and a mortgage or deed of trust giving the seller a recorded lien. The buyer owns the property immediately, and the seller can foreclose if payments stop.
Under a land contract, sometimes called a contract for deed, the seller keeps the deed until the buyer pays the full purchase price. The buyer takes possession and use of the property, but legal title does not transfer until the final payment. Sellers get more control, buyers usually get weaker protections. The note-and-mortgage structure is more common and more closely mirrors a bank loan, and most of the guidance below assumes that structure.
The Documents That Make It Real
Two documents do the work. The promissory note is the buyer’s written promise to repay. It sets out the principal balance, interest rate, monthly payment, due dates, late fees, and the consequences of default. This is the “note” in carrying the note.
The security instrument ties the debt to the property. In some states that document is a mortgage, which is a two-party agreement between buyer and seller. In other states it is a deed of trust, which brings in a neutral trustee who holds limited title and can conduct a foreclosure sale if the buyer defaults. Either way, the document is recorded with the county, creating a public record of the seller’s lien and establishing priority against anyone who might later claim an interest in the property.
Signing happens at the same closing where the deed changes hands. The deed moves ownership to the buyer; the buyer simultaneously signs the note and security instrument; the security instrument is recorded immediately. Timing and recording together are what protect the seller.
If the Seller Still Has a Mortgage
This is where seller-financed deals most often come apart. If the seller has not paid off their existing loan, transferring the property can trigger the lender’s due-on-sale clause. Federal law expressly permits lenders to include and enforce these clauses, which allow the lender to demand the full remaining balance as soon as the property is transferred without the lender’s consent.1Office of the Law Revision Counsel. 12 U.S. Code 1701j-3 – Preemption of Due-on-Sale Prohibitions
The statute carves out a short list of transfers lenders cannot accelerate, including transfers to a spouse, transfers at a borrower’s death, and transfers into certain trusts. A standard seller-financed sale to an unrelated buyer is not on that list.1Office of the Law Revision Counsel. 12 U.S. Code 1701j-3 – Preemption of Due-on-Sale Prohibitions If the lender finds out and calls the loan, the seller must pay the balance immediately or face foreclosure on the original mortgage. That foreclosure also wipes out the buyer’s interest.
Some sellers try to work around this with a wraparound mortgage. The original loan stays in place, and the buyer’s payments to the seller are large enough to cover both the old mortgage payment and the seller’s profit. The seller collects from the buyer and keeps paying the original lender. The danger is obvious. If the seller stops paying the underlying loan, or the lender discovers the transfer and accelerates, the buyer can lose the home even though they have been paying on time. Any buyer entering a deal where the seller still has an existing mortgage should insist on a title search and understand the due-on-sale risk before signing.
Federal Rules Sellers Have to Follow
Seller financing does not sit entirely outside federal lending law. Under the Dodd-Frank Act, anyone who originates a residential mortgage generally has to comply with licensing and ability-to-repay rules. The Consumer Financial Protection Bureau created two exemptions for property sellers who are not in the lending business.2Consumer Financial Protection Bureau. 12 CFR 1026.36 – Prohibited Acts or Practices and Certain Requirements for Credit Secured by a Dwelling
The one-property exemption covers a person, estate, or trust who seller-finances only one property in any 12-month period. The loan cannot have negative amortization. Balloon payments are allowed. The interest rate must be fixed, or if adjustable, cannot reset for at least five years.
The three-property exemption covers any seller, including business entities, who finances three or fewer properties in a 12-month period. Rules here are stricter: the loan must be fully amortizing with no balloon, and the seller must make a good-faith determination that the buyer can afford the payments.
Both exemptions require that the seller actually owned the property and was not the builder or contractor who constructed it as a regular business activity. The practical dividing line between the two is the balloon payment: a homeowner selling one property can include one, a seller doing multiple deals cannot. Exceeding the limits without a mortgage originator license risks enforcement action and loan rescission.
The Interest Rate Floor
Interest rate is negotiable, and that flexibility is one of the main attractions. Buyers who cannot qualify for a bank loan may accept a rate above market in exchange for access to financing. Sellers often earn a better return than they would on cash sitting in a bank account.
There is a floor, though. The IRS requires any seller-financed loan to charge at least the Applicable Federal Rate for the loan’s term. The AFR is set monthly and comes in three tiers: short-term for loans of three years or less, mid-term for loans between three and nine years, and long-term for loans over nine years.3Office of the Law Revision Counsel. 26 USC 1274 – Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property If the stated rate falls below the AFR, the IRS treats the difference as imputed interest. The seller owes tax on interest they never collected, and the shortfall can also count as a taxable gift to the buyer. Current AFR figures are posted monthly on the IRS site. Most seller-financed real estate deals run long enough that the long-term rate applies.
Balloon Payments and the Refinancing Problem
Most seller-financed deals do not run 30 years. A common setup is a five- to seven-year term with monthly payments calculated as if the loan were amortized over 20 or 30 years, followed by a balloon payment of the entire remaining balance at the end of the short term. Monthly payments stay affordable; the buyer needs a large payoff at maturity.
The exit is almost always refinancing into a conventional mortgage before the balloon hits. That works when credit has improved, the property has appreciated, and rates are reasonable. It stops working when any of those assumptions fail. A buyer who cannot refinance has to pay the balloon in cash, negotiate an extension with the seller, or default. This is the single biggest risk a buyer takes on, and it deserves attention before the note is signed. A longer term and a written option to extend if refinancing is not available at maturity are both worth negotiating.
Keep in mind that the three-property exemption prohibits balloons entirely. Only the one-property exemption permits one.2Consumer Financial Protection Bureau. 12 CFR 1026.36 – Prohibited Acts or Practices and Certain Requirements for Credit Secured by a Dwelling
Taxes on the Seller’s Side
When a seller carries the note, the IRS generally treats the transaction as an installment sale under Section 453 of the Internal Revenue Code. Instead of paying capital gains tax on the entire profit in the year of sale, the seller recognizes gain gradually as principal payments arrive.4Office of the Law Revision Counsel. 26 U.S. Code 453 – Installment Method Each payment splits three ways for tax purposes: return of original cost basis, which is not taxed; capital gain, taxed at capital gains rates; and interest income, taxed as ordinary income in the year received.
The seller reports installment sale income on IRS Form 6252 in the year of sale and in every year payments come in.5Internal Revenue Service. About Form 6252, Installment Sale Income The installment method applies automatically; no election is needed. A seller who would rather pay all the tax upfront can opt out and report the full gain in the year of sale.
Depreciation recapture is treated differently. Sellers who previously claimed depreciation, usually landlords and other investors, must report the recapture entirely in the year of sale even when using the installment method for the rest of the gain.6Internal Revenue Service. Topic No. 705, Installment Sales A rental owner who has taken years of depreciation deductions owes that tax right away, regardless of how little cash has actually arrived from the buyer. Plan for that upfront hit before closing.
Taxes on the Buyer’s Side
A buyer in a seller-financed deal can deduct the mortgage interest they pay, the same as a buyer with a bank loan, as long as the debt is secured by the property and qualifies as acquisition indebtedness under federal tax law.7Office of the Law Revision Counsel. 26 USC 163 – Interest The deduction requires itemizing, so a buyer taking the standard deduction will not capture it. For 2026, the mortgage interest deduction limit reverts to $1,000,000 of acquisition debt, or $500,000 if married filing separately, following expiration of the Tax Cuts and Jobs Act’s temporary $750,000 cap.8Congressional Research Service. Selected Issues in Tax Policy: The Mortgage Interest Deduction Most seller-financed deals sit well below that ceiling.
One administrative point matters. Sellers who are not in the business of lending are not required to send the buyer a Form 1098 at year’s end.9Internal Revenue Service. Instructions for Form 1098 – Mortgage Interest Statement A homeowner financing the sale of a personal residence has no obligation to file that form. The buyer can still claim the deduction using the promissory note, payment records, and amortization schedule. If a third-party servicer handles payments, documentation is simpler.
Who Collects the Payments
Once the deal closes, someone has to collect monthly payments, apply them correctly between interest and principal, track the balance, and keep records. The seller can self-service or hire a loan servicing company. Self-servicing avoids the fee but demands careful bookkeeping. Every payment needs a date, an interest allocation, a principal allocation, and an updated balance. Sloppy records breed expensive disputes because there is no institutional paper trail to rely on. A servicer collects payments, sends statements, handles any escrow for taxes and insurance, issues year-end tax documents, and leaves a clean independent record that protects both sides.
If the Buyer Stops Paying
A seller who stops receiving payments does not get to change the locks. The process starts with a written notice of default and a cure period, usually around 30 days, during which the buyer can catch up on missed payments and late fees. The cure window comes from the security instrument and state law.
If the default is not cured, foreclosure follows. The route depends on the security instrument and the state. Judicial foreclosure, used in mortgage states, moves through court. It is slower and more expensive but gives the buyer the chance to contest in a lawsuit. Non-judicial foreclosure, used in deed-of-trust states, lets the trustee conduct a statutory notice-and-sale process outside court. It is faster and cheaper but still bound by state timelines and notice rules.
Either way, the property is sold at public auction, and the proceeds pay off the remaining principal, accrued interest, and the seller’s legal costs. Surplus goes to the buyer. If the sale falls short, whether the seller can pursue the buyer for the difference depends on state deficiency judgment laws.
Carrying the note means carrying the risk of a long, costly foreclosure. A meaningful down payment, often 10% or more, gives the buyer real equity to protect and gives the seller a cushion if the property has to be auctioned for less than full value.