Definition
Seller financing is a transaction structure in which the property seller acts as the lender, allowing the buyer to make payments over time rather than securing traditional bank financing.
How It Works
- The buyer makes a down payment.
- The seller issues a promissory note for the remaining balance.
- The note typically includes interest, repayment terms, and maturity date.
- The property serves as collateral for the loan.
Common Structures
- Fully seller-financed transaction
- Seller carryback second mortgage
- Wraparound mortgage
- Interest-only note with balloon payment
Benefits to the Buyer
- Greater flexibility in underwriting.
- Faster closing timeline.
- Potentially lower transaction costs.
- Access to deals where bank financing is unavailable.
Benefits to the Seller
- Expanded buyer pool.
- Ongoing interest income.
- Potential installment sale tax treatment.
- Negotiating leverage on price or terms.
Risks
- Default risk: Buyer may fail to make payments.
- Liquidity risk: Seller receives payments over time.
- Market risk: Property value may decline.
- Legal complexity: Documentation must be properly structured.
Tax Considerations
Seller financing often qualifies for installment sale treatment, allowing capital gains to be recognized proportionally as payments are received. Interest income is taxed as ordinary income.
Example
A property sells for $2,000,000. The buyer puts down $400,000. The seller carries a $1,600,000 note at 6% interest with a five-year balloon payment.
When It Is Common
- High interest rate environments.
- Transitional or value-add properties.
- Family or closely held transactions.
- Estate and succession planning.