How owner financing works, for the seller

How does owner financing work?

The seller lends the buyer the money to buy the seller’s own property. Instead of the buyer getting a bank loan and handing you the whole price at closing, the buyer pays you part of it and the rest month by month, with interest. That is owner financing, also called seller financing; the two names mean the same thing.

A typical owner-financed sale has four parts:

1. The price and the down payment. You agree on a price. The buyer pays some of it at closing; that is the down payment.
2. The note. The rest becomes a loan from you to the buyer, written as a promissory note: a signed promise to repay a set amount at a set rate on a set schedule.
3. The security. A note is only a promise. To be able to take the property back if the buyer stops paying, the deal also needs a security instrument (such as a mortgage or deed of trust) or a contract in which you keep the title until the note is paid. Which one you can use is a matter of state law.
4. The payments. The buyer pays you every month. Each payment covers that month’s interest first, and the rest reduces what they owe, until the balance reaches zero.

You become the lender, with a lender’s upside (interest income, often a higher price) and a lender’s risks (late payments, default, paperwork). The rest of this page is about weighing those honestly.

Owner financing calculator: cash sale or carry the note?

The real question for a seller is whether payments over time are worth more than a cash sale today. Put in the cash price you could get, the price and terms you would offer, and the rate your money could earn instead. The calculator brings every payment back to today’s value so the two can be compared fairly.

The defaults are hypothetical: a $6,500 cash offer, or $7,500 on terms with $1,500 down and $6,000 at 15% for 36 months. If every payment arrives and your money could earn 8% elsewhere, the terms are worth about $8,137 today, about $1,637 more than the cash. The next two sections work that out by hand.

How do you calculate an owner financing payment?

Use the standard loan payment formula with the monthly rate and the number of months. It is the same formula a bank uses.

$8,988 looks much better than $6,500, but those dollars arrive over three years, and some might not arrive at all. The next section puts them on the same date.

Is it better to take cash or carry the note?

Carrying the note is better only if the payments, valued today, beat the cash price by enough to pay you for the risk. To value the payments today, discount each one at the rate your money could earn instead. That gives the present value of the payments.

The answer depends heavily on the rate you use. Here is the same offer valued at different rates:

The break-even rate is about 28.4% as a note rate (the monthly rate × 12, the way notes are quoted), or 32.4% compounded over a year. In dollars: by not taking the cash, you leave $5,000 tied up with the buyer (the $6,500 you could have had, less the $1,500 down) and collect $7,488 over 36 months, $2,488 more, with your $5,000 back in month 25 if every payment comes. Use a higher rate for a riskier buyer: a note that might not be paid in full is worth less than one that will.

Two lessons. A longer note collects more interest but takes far longer to return your money, so the rate you value it at matters more. And the higher price on terms is part of the deal: a seller who carries the note is usually paid twice, once in the price and once in the interest.

What can you sell with owner financing?

Almost anything with a buyer and a price. The rules and the risks change with what it is:

• A house. The classic case. A home someone lives in is a “dwelling” under federal lending rules, so the rules below matter most here. If you still owe on it, the due-on-sale question comes first.
• Land. Lots and acreage are often sold on terms. Bare land is not a dwelling, but consumer lending rules can still apply if you sell to people on terms often enough.
• Mobile homes. Federal rules count a mobile home or trailer used as a residence as a dwelling, whether or not it is attached to land. Small, cheap homes are where a note can earn the most on the least cash, and also where lot rent, titling and the high-cost line come in.
• A small business. An owner selling a shop or a route often takes part of the price as a note from the buyer. Credit mainly for a business purpose is exempt from Regulation Z, but contract law, your state’s rules and taxes still apply.

Owner financing pros and cons for the seller

The short version: you can get a higher price and steady interest, in exchange for waiting and taking on the risks a bank would carry.

One thing that is not a pro: buyers who cannot get a bank loan. A buyer a bank turns down may still be a fine buyer, but a seller’s job is to make sure they can actually afford the payments, for their sake and yours. The federal rules below expect it.

What can go wrong: default, prepayment, servicing and due-on-sale

The buyer stops paying

This is the big one. Say the buyer in the $6,000 example makes 8 payments and stops. You have collected $3,164 (the $1,500 down plus 8 payments of $207.99), and the buyer still owes $4,888. To get the property back you follow the remedy your paperwork and your state allow, which takes time and money, and the property may come back damaged. A larger down payment is your cushion: it is cash you keep however things go.

The buyer pays off early

A prepayment is good news for your cash and bad news for your interest. If the buyer refinances after 12 payments, they hand you the $4,290 balance and your interest stops at $786 instead of $1,488. If you were counting on the income, plan for the chance it ends.

Running the loan

Someone has to record each payment, split it into interest and principal, chase late payments and send the buyer a year-end statement. That job is called servicing. You can do it yourself or pay a servicing company; either way, sloppy records cause disputes later.

You still owe a mortgage on the property

Most mortgages include a due-on-sale clause: a term that lets your lender, at its option, demand the whole balance if you sell or transfer the property without its written consent. Federal law lets lenders enforce these clauses on real property loans. It lists exceptions, such as a transfer to a relative when the borrower dies or to a spouse in a divorce, but selling to a buyer on terms is not one of them. Selling on terms over an existing loan without the lender’s consent risks the loan being called. Ask your lender and an attorney first.

What are the seller financing rules?

Two separate questions decide which federal rules apply, and they are often mixed up. Both come from Regulation Z, the rule that carries out the Truth in Lending Act; each row below links to the Consumer Financial Protection Bureau’s copy of the rule.

1. Are you a “creditor”? Regulation Z covers credit that is offered regularly, and its disclosures and the ability-to-repay rule fall on creditors. You are one only if you extend consumer credit regularly, and the rule counts how often.
2. Are you a “loan originator”? A separate set of rules covers loan originators: how they are paid, steering, qualification, and putting a name and NMLSR ID on loan documents. Two seller-financer exclusions take qualifying sellers out of this definition, and only this definition.

What does owner financing cost the buyer?

The buyer’s side is the same numbers turned around. On the $6,000 note at 15% for 36 months, the buyer pays $207.99 a month and $8,988 in all for a $7,500 home, $1,488 of it interest. The same $6,000 at 12% would cost $1,174 in interest ($199.29 a month); at 9%, $869 ($190.80 a month).

Fees change the picture. If the buyer also paid $300 in fees at signing on the 15% note, the APR (annual percentage rate, which counts fees as part of the cost of the money) would be about 18.7%, not 15%. A fair deal is one the buyer understands and can afford, with every term in writing.

How do you do owner financing math in Excel or Google Sheets?

The same functions work in both. Money going out is entered as a negative number.

RATE returns a monthly rate, so multiply by 12 for the note rate. For a full payment schedule, use the calculator in the loan amortization guide.

Before you sell on terms

• Price it both ways. Know the cash price and what the terms are worth today at a rate that fits the buyer’s risk.
• Check your own loan. If you owe a mortgage, read the due-on-sale clause and ask the lender.
• Count your sales. How many loans secured by a dwelling did you make last calendar year, and how many high-cost loans in the last 12 months? Those counts decide whether you are a creditor.
• Check the buyer can pay. Income, other debts and the full monthly cost of the property, in writing. It protects you both.
• Keep the note simple. A fixed rate and a payment that pays the loan off in full fit both federal exclusions.
• Check your state. Interest caps, licensing, the security instrument you can use, and what you may do on default.
• Plan the paperwork. Who services the loan, where payments go, what counts as late, and how the buyer gets statements.

If you are not yet the one collecting interest, the first step is usually to stop paying it. The leak check finds the interest and fees you pay now.