Holding a Mortgage: Pros and Cons for Sellers and Buyers

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You've worked hard to pay off your home. But the time has come to sell.

Whether upgrading, downsizing, or moving to a new state – you're in the financial position to “act as the bank” for the new buyers.

Holding a mortgage note is one type of seller financing. It is also known as owner-financing, a private mortgage, or a purchase-money mortgage and is an alternative investment option.

Other types of seller direct financing include land contracts, lease-to-own options, assumable mortgages, wraparound mortgages, or junior mortgages.

Owner financing is one way for homeowners or landowners interested in selling their real property to diversify their investments and streams of income.

What Does Holding a Mortgage Note Mean?

Holding a mortgage refers to an agreement by the current property owner to extend credit to a buyer purchasing their home, land, or other real property.

a hand holding an illustration of a house

In exchange for providing the loan to the buyer of their property, the seller earns interest on the loan.

The buyer makes an agreed-upon down payment and pays monthly payments for the mortgage note over a set period directly to the seller instead of a bank, credit union, or traditional mortgage lender.

How Does Owner Financing Work?

With this common type of real estate deal, you and a buyer agree on a purchase price for your property, and details of the financial arrangement are recorded.

The amount of the seller financing is the sales price minus the down payment.

The seller financing agreement usually includes a promissory note regarding the repayment and terms of the loan.

interest rate
loan period
mortgage payment amount
balloon payments due
prepayment rules

Penalties, fees for late payments, a due-on-sale clause, and default procedures are also typically included in the financing agreement. It may also contain information on the payment requirements for homeowners' insurance premiums and property taxes.

You can view a template and directions for creating an owner-financing contract with a promissory note on the SignNow website.

A private mortgage is also generally written to secure the property as collateral for the loan.

Note: It may be a requirement to record the mortgage contract with the local public records office.

It's strongly suggested to have a real estate attorney or other qualified professional complete the necessary paperwork for a seller-financed deal.

A lawyer or title company can also review any agreements, including the sales contract you or your real estate agent generated during the selling process.

Real estate investors will tell you that taking precautions and performing your due diligence at the beginning of the sale is critical to ensure proper handling of all paperwork and legalities.

Working with real estate professionals may save you a tremendous amount of time, money, and aggravation should problems arise with the property or loan repayments over time.

A seller-financed real estate transaction benefits both you as the seller and the individual or individuals buying. Still, some drawbacks occur for each too. Both are described below.

Benefits for Sellers Holding a Mortgage Note for the Buyer

Even though owner financed home sales don't happen every day, sellers wouldn't hold mortgages if they didn't benefit.

1. Monthly Income

One of the most significant benefits of an owner carrying the finance agreement is the monthly passive income it provides to the seller.

Sellers usually accept a down payment at the time of purchase. Then they receive monthly principal and interest payments from the buyer.

When you don't need a large lump sum of money when selling your paid-off home, this adds a source of income with an interest rate that may be higher than some of your other financial investments.

As the seller, you determine the loan terms, including the interest rate and payment terms.

Like many other owners selling, you may opt to require a balloon payment of the entire outstanding loan balance after five or ten years.

A balloon payment loan allows you to collect payments for many years but still receive the balance of your money due in a much shorter time frame than a traditional 30-year bank mortgage.

It may also reduce taxes on the sale of the home by spreading out the income over several years versus incurring capital gains taxes in one year.

While the original agreement's balloon payment option is important for most sellers to include, you also have the option to extend your seller-financed mortgage if the financial relationship works well for both parties.

Keep in mind that you will need to pay taxes on the interest income you earn when you hold a mortgage.

2. Larger Pool of Buyers

Offering seller financing may attract more potential buyers to your property and allow a faster closing on your property.

If buyers don't have to navigate the traditional mortgage loan process with a financial institution, your property may be sold in as little as a few weeks to a month.

In some states, the closing can take up to two months or more when bank mortgages are involved.

3. Higher Profit on Sale

You may also be able to sell your property at a higher price when offering a seller-financed mortgage while avoiding certain repairs required by lenders who won't issue a mortgage without their completion.

While the potential buyer may push back and cancel the deal without you completing some repairs or at least some negotiation on their cost, you ultimately decide to sell “as-is” or refuse the offer.

Offering to hold a mortgage may also result in buyers paying your asking purchase price (or higher) because the process is usually more straightforward and more flexible.

4. Rights to Property in Case of Non-Payment

The ability to foreclose on the property allows you to take the property back if the buyer defaults on payments or walks away from the property.

You also get to keep the down payment and any payments made on the property before the foreclosure.

Drawbacks for Sellers Holding a Mortgage

Even though there are many advantages, sellers must understand the negatives of holding a mortgage note.

Most sellers' biggest concerns are a failure to maintain the property and buyers not making loan payments.

Even with a clean credit history, there might be a hidden reason the buyer isn't seeking traditional financing.

If the buyer stops making payments, you must enter legal proceedings to foreclose on the property. You may become the owner again if the buyer cannot pay what they owe.

If this happens a few years into the loan, you may have thousands of dollars of profit. But the amount of damage to the property could be significant due to years of neglect too.

If a buyer walks away early on, there may be fewer problems. But less money has been paid to cover legal costs and make repairs over this time as well.

This is why getting a down payment large enough to cover significant expenses is essential.

Another risk to consider when you provide owner financing is tying up a large sum of money that could be used or invested in other ways for an extended period.

two hands around an illustration of a crystal ball with a house appearing in it

Lending practices have also affected some sellers' ability to offer financing on real estate in the last decade.

The financial crisis of 2007-2008 led to the Dodd-Frank Act of 2010. This legislation exists to help protect consumers from predatory lending practices.

It would likely not impact you holding a note for one property, but if you plan to offer seller financing on your home or land, discuss this with your attorney and real estate agent.

Benefits of Seller Financing for Buyers

1. Less Hassle/Time Required

One of the most significant advantages for potential buyers is not having to deal with the hassle and time required to get a bank issued mortgage.

Owners willing to provide a private mortgage may also have more lenient qualifications on items such as credit scores than conventional financing offered by banks or mortgage lenders.

This can speed the mortgage process and allow buyers to purchase a home they may not otherwise be able to buy.

The down payment may also be less than a traditional lender would require – helping a buyer who lacks substantial savings but still wants to buy a house.

For buyers with poor credit or those needing small mortgages that many banks are not interested in extending, owner financing saves time and money over searching for a lender.

2. May Avoid PMI

Buyers may also avoid paying for private mortgage insurance (PMI) a mortgage lender requires if a 20% down payment isn't made.

3. Costs Negotiable

When sellers want a fast sale, buyers may be able to negotiate decent loan terms and interest rates.

While interest rates may not be as low as a bank offers, owner financing deals often have much lower closing costs for buyers.

If the interest rates aren't great, buyers may get better rates if they refinance when they qualify for a loan or at the time of the balloon payment.

Sell the House or Rent it Out? [What to Consider]

Drawbacks of Owner Financing Agreements for Buyers

A buyer may put down a smaller down payment and close quickly on their new home with seller financing.

Yet they may pay more in the long run if the loan comes with a higher interest rate than a bank offers.

Buyers also have to consider how they'll pay off the balloon payment if one is part of the terms of the financing agreement.

Buyers will need to come up with the funds or seek approval for a traditional mortgage.

They can't assume you'll renegotiate a new loan with them, even if they've been prompt with payments over the years.

Ways Sellers Can Protect Themselves

As mentioned, the legal paperwork required for seller financing should be drafted or reviewed by an attorney or qualified professional familiar with the process.

Even if you are selling to family, friends, or someone with a stellar credit score and long work history – this is not a time to “DIY” legal documents and hope for the best.

You should also consider getting an appraisal on your house to understand the market value.

An appraisal will help you negotiate purchase offers and determine an acceptable amount for a down payment.

Talk with your attorney or real estate agent about using a mortgage application and credit check.

You'll want to review the credit report carefully and verify potential buyers' employment history and assets.

Checking references is integral to the application process for seller financing arrangements.

Is Holding a Mortgage a Good Way To Make Money?

Depending on your financial circumstances, providing an owner financed mortgage as a seller can be a great way to make money and build wealth.

Financing the sale of your property and creating a win-win solution for you and the buyer may help you obtain a competitive price for your home or investment property.

And it can allow you to earn extra money by collecting interest as part of the loan via monthly mortgage payments.

As the seller, if you put in the work and money upfront to get the professional help you need, it's possible to find a qualified buyer and make money from seller financing.

There are no guarantees the buyer will follow through, make regular payments, and keep the property up, though – so there's risk involved with this type of financing.

Still, many real estate owners feel the money they can make holding a mortgage note worth the risk.

Our Personal Experience With Seller Financing

Women Who Money Cofounder Vicki and her husband hold the mortgage on a commercial, residential property they owned for over a decade.

The owner financing arrangement we created has benefited us and our property's buyers.

We received a sizeable down payment at the time of the sale and enjoy monthly income from the private mortgage and interest payments.

Our real estate attorney suggested a 5-year balloon payment, and our buyers have expressed an interest in extending the financing.

We currently plan to renegotiate the arrangement when the balloon comes due in just over a year and increase the interest rate based on current market rates.

This stream of income has helped us diversify our wealth building strategy and spread out capital gains tax over several years.

Next: Sell Home By Owner or Use a Real Estate Agent?

Written by Women Who Money Cofounders Vicki Cook and Amy Blacklock.

Amy and Vicki are the coauthors of Estate Planning 101, From Avoiding Probate and Assessing Assets to Establishing Directives and Understanding Taxes, Your Essential Primer to Estate Planning, from Adams Media.