Do I need both a promissory note and a mortgage for seller financing?

Yes. The promissory note is the IOU - the borrower's promise to pay. The mortgage or deed of trust is the security - it gives the lender the right to foreclose if the borrower defaults. One without the other leaves you with either an unsecured debt or an empty lien.

Does Dodd-Frank apply to a seller-financed home?

It can. Sellers who finance more than 3 properties per year are treated as mortgage originators and must comply with full Dodd-Frank rules. Sellers financing 1 to 3 properties per year (the more common case) get exemptions but still must avoid balloon payments shorter than 5 years on owner-occupied homes and must verify ability to repay.

What interest rate is allowed?

At least the AFR for tax purposes (intra-family or below-market loans only). Up to your state's usury cap for the maximum. Most seller-financed home notes run 5 to 8 percent in normal rate environments, often a couple of points above conventional mortgage rates because the seller is taking the risk a bank declined.

What if the buyer stops paying?

Foreclose, the same as a bank. Each state has either judicial foreclosure (lawsuit, can take 6 to 18 months) or non-judicial foreclosure under a deed of trust (faster, often 3 to 6 months). Your foreclosure rights come from the mortgage or deed of trust you recorded at closing.

Can I sell the note later?

Yes. A seasoned (paying for 12+ months) seller-financed note can be sold to a note buyer at a discount, typically 70 to 90 cents on the dollar depending on rate, LTV, and borrower credit. This converts your monthly income stream into a lump sum.

Seller Financing on a Private Home Sale

You sold your home to a buyer who is paying you over time. The deal is two documents working together: a promissory note (the IOU) and a mortgage or deed of trust (the lien). Get both right and you have a steady monthly income with the home as collateral. Get either one wrong and you have a problem the size of a house.

The two documents and what each one does

Promissory note. The borrower\'s personal promise to pay you. States the principal, interest rate, payment schedule, maturity, late fees, and default consequences. It is a private contract, kept by the lender.

Mortgage or deed of trust. The collateral document. Gives you a recorded lien on the home so you can foreclose if the borrower defaults. Recorded at the county recorder\'s office. Public record.

Most states use mortgages (judicial foreclosure). About 20 states use deeds of trust (non-judicial foreclosure, faster). Use the document type for your state.

Dodd-Frank limits for casual seller financing

Federal law (Dodd-Frank Act, SAFE Act) regulates seller financing for owner-occupied 1-to-4-unit homes. The rules:

Sellers financing more than 3 homes per year: full mortgage originator licensing and compliance required. Most sellers do not qualify and should use a licensed loan originator (RMLO).
Sellers financing 1 to 3 per year: exempt from licensing but must:
- Not include a balloon payment due in less than 5 years (for owner-occupied)
- Have a fixed rate or adjustable rate that resets no more often than annually
- Make a "good faith determination" the buyer can repay
Sellers financing 1 home per year (and not the builder): further exemptions, balloon payments allowed

For non-owner-occupied (investment) buyers, Dodd-Frank does not apply.

Typical structure for a private home sale

Down payment: 10 to 25 percent (the more, the better the buyer\'s skin in the game)
Note amount: sale price minus down payment
Interest rate: 1 to 3 points above conventional mortgage rates
Term: 15 to 30 years amortization (with or without balloon)
Payment schedule: monthly principal + interest, often with escrow for taxes and insurance
Late fee: 5 percent of the missed payment (or your state cap)
Default: typically 30 days past due, with cure period
Acceleration on default

Closing day: what happens

A real closing with a title company or attorney is strongly recommended. The closing produces:

Warranty deed transferring title to the buyer
Mortgage or deed of trust securing your loan, recorded at the county
Promissory note signed by the buyer and held by you
Title insurance (lender policy) protecting your lien position
Escrow setup for taxes and insurance if applicable
Payment of any pre-existing mortgage that has to be paid off (you cannot keep your old mortgage in place if you have a "due-on-sale" clause)

Due-on-sale: the trap when you have an existing mortgage

Most existing mortgages have a "due on sale" clause. Selling the home (even with seller financing) triggers the clause and the bank can demand full payoff. Two ways to handle it:

Pay off the existing mortgage at closing from buyer\'s down payment plus your own funds. Then the buyer\'s payments are pure income to you.
"Wrap" the existing mortgage (buyer\'s payments cover your existing mortgage payment, plus extra to you). Higher-risk if the bank finds out and accelerates.

Wraps work best when interest rates have risen significantly above your existing mortgage rate. They carry real risk. Talk to a real estate attorney.

Tax treatment for the seller

Seller financing usually qualifies for installment sale treatment. You report capital gain over the years as you receive principal payments, rather than all in the year of sale. Interest is reported as ordinary income each year. Form 6252 in each year you receive payments.

If the home was your primary residence, the Section 121 exclusion ($250,000 single, $500,000 married) still applies. You can structure the sale so the gain is fully excluded, and only the interest is taxable.

Default and foreclosure

If the buyer stops paying:

Send a written notice of default with the cure period from the note (typical 30 days)
If not cured, send a notice of acceleration
Refer to a foreclosure attorney - judicial foreclosure (most states) takes 6 to 18 months; non-judicial under deed of trust takes 3 to 6 months
You can buy back the home at the foreclosure sale (often by credit bidding the unpaid balance)

Once you have the home back, you can sell again. Seller-financing notes are full of stories of homes sold three or four times to different buyers, each time at the going market price.

Escrow, insurance, and the property tax problem

Property taxes and homeowner insurance are easy to overlook. If the buyer stops paying property tax, the county can foreclose ahead of your lien. If they let insurance lapse and the home burns, your collateral is gone.

Two solutions:

Require escrow: the buyer pays 1/12 of annual taxes and insurance with each monthly payment. You hold the escrow and pay the tax and insurance bills.
Force-place: the loan documents allow you to pay the tax or insurance if the buyer fails, then add the cost to the loan balance.

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