Holding a Mortgage Note to Make Money: Pros and Cons

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

Whether you’re 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, also known as seller-financing, owner-financing, or private mortgage, is an alternative investment option.

It’s 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. The seller, in exchange for providing the loan to the buyer of their property, earns interest on the loan.

The buyer makes an agreed-upon down payment and pays monthly payments for the mortgage note over a period of time directly to the seller instead of a bank or mortgage company.

a hand holding an illustration of a house

How Does Owner Financing Work?

After a buyer and seller come to an agreement on a purchase price for the property, the details of the financial arrangement are recorded. The amount of the seller financing is the sales price minus the down payment. The financing arrangement usually includes a promissory note regarding the repayment and terms of the loan.

The note includes information such as:

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

Penalties, fees for late payments, and default procedures are also typically included in the financing agreement.

A private mortgage is also generally written securing 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 the financing. A lawyer or title company can also review any agreements or contracts you or your real estate agent generated during the selling process.

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

It may save you a tremendous amount of time, money, and aggravation should problems arise with the property. Or on the loan repayments over the years.

A seller-financed real estate transaction offers benefits to both the seller and the buyer. Still, there are some drawbacks for each too when the seller is carrying the note, as described below.

Benefits for Sellers Who Hold the Mortgage Note for the Buyer

Even though owner financed home sales are not very common, 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.

For owners not needing a large lump sum of money when they sell their paid-off homes, this adds a source of income with an interest rate that may be higher than some of their other financial investments.

Sellers determine the terms of the loan, including the interest rate and payment terms. They often require a balloon payment of the entire outstanding loan balance after five or ten years.

This allows sellers to collect payments for many years but still receive the balance of their money 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.

2. Larger Pool of Buyers

Offering seller financing may attract more potential buyers to your property and allow you to close the deal more quickly.

If buyers don’t have to navigate the mortgage process with a bank, the sale of your house may happen in just 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

An owner may also be able to sell their 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 the completion of some repairs or at least some negotiation on the cost of them, the seller ultimately gets to decide about selling “as-is” or refusing the offer.

4. Rights to Property in Case of Non-Payment

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

The owner also gets to keep the down payment and any payments made on the property before the foreclosure.

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 mortgage.

Owners willing to provide a private mortgage may also have more lenient qualifications than banks or other mortgage lenders. This can speed the process and allow buyers to purchase a home they may not otherwise be able to buy.

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

For buyers needing small mortgages that many banks do not have an interest 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) required by a mortgage lender if a 20% down payment isn’t made.

3. Costs Negotiable

If the seller wants 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, seller 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.

Drawbacks for Sellers Holding a Mortgage

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

The biggest concern most sellers have is buyers not making loan payments and not maintaining the property. There might be a hidden reason the buyer isn’t seeking traditional financing.

The seller then has to enter legal proceedings to foreclose on the property. If the buyer cannot pay what they owe, the seller becomes the owner again.

If this happens a few years into the loan, sellers 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 it’s essential to get a down payment large enough to cover some major expenses.

Another problem for sellers who provide 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 passage of the Dodd-Frank Act of 2010. This legislation exists to help protect consumers from predatory lending practices.

It would likely not impact a seller 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.

Drawbacks of Owner-Financing for Buyers

A buyer may put down a smaller down payment and close quickly on their new home with seller financing. But 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 either need to come up with the funds or seek approval for a traditional mortgage. They can’t assume the seller will re-negotiate a new loan with them, even if they have been prompt with payments over the years.

Ways Seller’s can Protect Themselves

As mentioned before, the legal paperwork required for seller financing should be drafted or at least 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, so you understand the market value. This will help you negotiate purchase offers and determine what is 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 the employment history and assets of potential buyers. Checking references is an integral part of the application process too.

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 your 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 up front 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 is risk involved with this type of financing. But many real estate owners feel the money they can make holding a mortgage note worth the risk.