Patricia L. Pregmon, Esq., and Andrew M. Loza authored the 2009 and 2019 editions of this guide. Justin Hollinger, Esq., and Loza updated the guide for 2024.
WeConservePA produced this guide with support from the Colcom Foundation, the William Penn Foundation, and the Community Conservation Partnerships Program, Environmental Stewardship Fund, under the administration of the Pennsylvania Department of Conservation and Natural Resources, Bureau of Recreation and Conservation.
Nothing contained in this document is intended to be relied upon as legal advice or to create an attorney-client relationship. The material presented is generally provided in the context of Pennsylvania law and, depending on the subject, may have more or less applicability elsewhere. There is no guarantee that it is up to date or error free.
When a seller wants to close a sale of real estate but the buyer is not yet in a position to fully fund the purchase, the parties can close the sale with the seller taking from the buyer a purchase money note and mortgage in lieu of an all-cash payment.
If a buyer needs time to raise money to purchase a property, and the seller (1) doesn’t want to wait to close the sale and (2) is willing to defer payment in full for the needed time, there are two ways forward:
Either financing alternative provides the buyer the right to use the property while paying off the purchase price. In either case, the seller can defer recognition of capital gain on the sale for federal tax purpose over a period of two or more years.
Of the two alternatives, seller take back financing provides a more secure position for the buyer. By taking title at the beginning of the payment period, the buyer may be afforded clearer and more robust legal rights in the event of an alleged default.
However, an installment agreement may provide solutions to a variety of practical problems. For example, it is notoriously more challenging to fundraise for a project after a property has changed hands as compared to before. It is best to use seller take back financing in the context of having pledges or relative certainty in advance rather than thinking that fundraising will somehow get easier after the transaction. In the absence of such certainty, a buyer may decide that a well-drafted installment agreement (with its payment period culminating in acquisition of title) may better complement fundraising efforts. The ability of a seller to retain title until final closing may also be a valuable inducement.
Sellers frequently help buyers obtain favorable financing by taking back a purchase money note secured by a mortgage on the property. Seller take back financing is a conventional tool and is substantially the same in a conservation transaction context as in any other loan transaction involving real estate.
Seller take back financing is sometimes referred to by other names, such as seller financing, owner financing, or carryback financing. Note that these terms are colloquial and may also be used to refer to an installment arrangement, so it’s important to inquire about the actual intent of any party using them in a financing proposal or discussion.
A seller take back loan is a unique type of financing where the seller provides a loan directly to the buyer as part of a real estate transaction, This creative financing method allows buyers to purchase properties they may not otherwise afford while giving sellers a way to sell their home and generate ongoing income
In this comprehensive guide we will explore what seller take back loans are how they work, their pros and cons, eligibility requirements, and how to structure a solid seller financing agreement.
What is a Seller Take Back Loan?
A seller take back loan, also called owner financing or a purchase money mortgage, is when the seller of a house provides financing to the buyer for a portion or all of the purchase price. This allows the transaction to be completed without the buyer having to qualify for a traditional bank loan for the full amount.
With a seller take back loan, the buyer makes mortgage payments directly to the seller over a set period of time, such as 5-30 years. The seller retains legal ownership until the loan is satisfied. These loans are usually secured by a second mortgage or deed of trust on the home.
Seller financing can make transactions possible that otherwise would not occur because buyers either don’t qualify for enough mortgage financing or cannot come up with a full down payment. It bridges the gap between what banks will lend and the total funds needed.
How Do Seller Take Back Loans Work?
Seller take back loans involve the seller carrying back a note and mortgage for a portion, or sometimes all, of the purchase price when selling their home. Here is the basic process:
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Buyer makes offer to purchase with request for seller financing.
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Seller counteroffers with the terms of the loan, including interest rate, down payment, and time to repay.
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Loan terms are negotiated and finalized in the purchase contract.
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At closing, the buyer makes down payment and signs a promissory note to repay the seller loan balance.
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The loan is secured by a mortgage or deed of trust filed against the property.
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Buyer makes monthly payments directly to the seller.
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After loan is repaid, seller releases the lien on the property.
The seller carry back loan acts as a second mortgage that the buyer pays off over time until the seller no longer retains any interest in the property.
Pros and Cons of Seller Take Back Loans
Seller financing has advantages for both the buyer and seller, but there are some risks to consider as well.
Pros for Buyers
- Easier qualification than traditional financing
- Lower down payments and costs
- Customized loan terms
- Potentially lower interest rates
Cons for Buyers
- Higher interest rates than conventional loans
- Risk of foreclosure if payments can’t be made
- Limits future borrowing abilities
Pros for Sellers
- Way to sell a home faster and for more
- Generates ongoing income from the interest
- Lower taxes on installment sale profits
Cons for Sellers
- No lump sum cash from sale proceeds
- Risk of default if buyer stops paying
- Legal costs to setup financing docs
Using creative seller financing allows deals to happen, but both parties take on some risk in exchange.
Seller Take Back Loan Requirements
For a seller to offer financing, there are some requirements they typically need to meet:
- Own the property free and clear – no existing mortgages
- Have clear property title with no disputes
- Have enough equity in the property to secure a loan
- Be willing to act as lender, collector, and if needed, enforcer
- Have the financial ability to foreclose if buyer defaults
In addition, the property itself should:
- Appraise for enough to secure both mortgages
- Pass inspections with no major issues
- Generate enough rental income to cover payments if needed
Meeting these requirements protects the seller and shows the lender their capacity to provide financing.
How Much Down Payment is Needed?
One main benefit of seller financing is the ability to buy with less down. While conventional mortgages require at least 3-20% down, seller take back loans often need just 5-10% down.
With as little as 5% down, a $500,000 purchase only requires $25,000 upfront instead of $100,000 with 20% down. Lower down payments open home ownership to more buyers.
What is a Typical Interest Rate on Seller Loans?
Interest rates on seller take back loans are usually a bit higher than conventional mortgage rates. This compensates the seller for the increased risk over banks.
Typical interest rates for seller financing range from 5% to 8% on average currently. But anything from 3% to 12% can be negotiated depending on factors like:
- Buyer’s finances and credit score
- Loan-to-value ratio
- Loan amount and term length
- Overall real estate market rates
Higher credit buyers can often get lower rates around 3-5%, while higher risk borrowers pay rates of 8-10% or more. The rate offers flexibility in cost for the buyer balanced with return for the seller.
Loan Terms to Consider
Some key terms that can be negotiated for a seller take back loan include:
Loan Amount – Seller can carry back from 5% to 100% of the purchase price.
Length of Loan – Typically 5 to 30 years. Shorter is less risk for seller but costs buyer more.
Down Payment – Often 5% to 20%. Lower means the seller is relying more on property value.
Interest Rate – Usually a bit above market averages but with room to negotiate.
Payment Schedule – Monthly, bi-weekly, bi-monthly, quarterly, or annual payments.
Pre-Payment Penalty – May have fees if buyer pays loan off early.
Late Fees – Set a penalty rate for late payments, such as 5% of the monthly payment.
Escrow – Option to have seller manage property taxes and insurance payments.
The exact loan conditions should be specified in the financing section of the purchase agreement.
Seller Take Back Loan Documents
Legally documenting the loan is important to protect both parties. Key financing documents typically include:
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Promissory Note – Details loan amount, interest rate, payment schedule, and terms.
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Security Instrument – Mortgage or deed of trust making the loan collateralized.
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Purchase Agreement – Specifies financing terms accepted by buyer and seller.
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Settlement Statement – Loan disbursements and credits shown at closing.
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Truth-in-Lending Disclosure – Shows total costs of financing like an APR.
Proper documentation ensures theterms are binding and the loan can be enforced. Having an attorney review is highly recommended.
How Seller Take Back Loans Are Taxed
There are special tax considerations for both buyers and sellers with owner financing:
Buyers
- Can deduct mortgage interest payments on Schedule A
- Payments not taxable to seller until principal is paid
Sellers
- Create potential capital gains tax liability if property appreciated
- Owed taxes on interest received not principal
- May qualify for installment sale tax breaks
Consulting tax professionals to structure the arrangement optimally is wise. There are often ways to minimize taxes for both parties.
Steps in the Seller Financing Process
The typical steps involved in the seller take back loan process are:
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Buyer requests seller financing in initial offer
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Seller sends back proposed financing terms
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Final loan details negotiated and added to purchase contract
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Buyer deposits earnest money to secure agreement
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Loan documents prepared for closing
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Down payment made and papers signed at settlement
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Buyer takes possession and begins making payments
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Seller services the note until paid off
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Lien is released once loan balance reaches zero
This demonstrates the lifecycle of the transaction for both buyer and seller.
Programs Similar to Seller Financing
Beyond traditional seller carry back loans, there are some other financing programs that share similarities worth considering:
Lease-Option – Buyer leases property with option to buy within a set timeframe. Each lease payment credits towards the purchase.
Rent-to-Own – A blend of renting and buying where portions of rent go toward the home purchase.
Contracts for Deed – Like a lease-option but involves two installment contracts rather than a lease.
Assumption – Buyer takes over seller’s existing mortgage instead of needing new financing.
Home Equity Loan – Seller uses equity in a property to provide financing to buyer.
Credit Unions – Offer member-to-member sale financing programs.
Community Banks – More flexible than mega banks on creative financing options.
These alternatives provide other paths to creatively finance real estate.
Risks to Consider
Before entering into a seller financed sale, buyers and sellers should weigh these key risks:
Buyer Risks
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Overpaying if home appraises for less than sale price
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Not being able to obtain additional financing neede
Benefits to the Seller
The primary benefit to the seller for selling to the buyer on credit, aside from selling the property sooner rather than later, is the opportunity to implement tax, estate, and financial planning strategies during the term of the financing, as discussed in more detail below.
Not Suitable for Conservation Easements
Seller take back financing is highly inadvisable for a conservation easement transaction as it necessarily involves the right of a landowner to retake the property in the event of default. This would forfeit potential federal tax benefits in the case of a bargain sale due to conservation easement perpetuity requirements and, more generally, introduce potentially confounding complexities regarding application of the law.
Sellers frequently help buyers obtain favorable financing by taking back a purchase money note secured by a mortgage on the property. Seller take back financing is a conventional tool and is substantially the same in a conservation transaction context as in any other loan transaction involving real estate.
Seller take back financing is sometimes referred to by other names, such as seller financing, owner financing, or carryback financing. Note that these terms are colloquial and may also be used to refer to an installment arrangement, so it’s important to inquire about the actual intent of any party using them in a financing proposal or discussion.
What is a Vendor Take-back Mortgage Loan? (VTB Loan)
FAQ
What is a seller takeback loan?
What are the benefits of seller carryback?
What are the risks of seller carryback?
Can a loan be taken back after closing?