How Does Seller Financing Work in a Home Sale?

Perhaps you've been looking for an affordable house to buy, but finding this to be no easy task given your income level and not entirely perfect credit record. Then you notice an ad for a house that says "Seller financing available!" What does this mean, and can it help you fulfill your home-purchasing dream?

Why Home Sellers Offer Financing to Buyers

It's rare, but a home seller might agree to loan a buyer part or all of the money to buy the property so as to create an incentive for buyers who can't borrow enough from a bank or commercial lender to buy the house.

Or, the seller's reasons could be tax related, since financing the purchase would allow the seller to spread out the income from the sale over a number of years.

How to Structure a Sale With Owner Financing

Seller financing can be carried out in one of two ways.

The first is for the seller to "take back" a mortgage on the house. You, the buyer, sign both a promissory note (promising to repay the loan) and either a mortgage or a deed of trust (allowing the seller to foreclose if you fail to pay). In return, the seller signs a deed transferring title to you. Because you hold the title, you can sell the house or refinance. But you must keep making the agreed-upon payments to the seller.

The second and less popular possibility is for the seller to keep title to the property for as long as it takes you to pay off the loan. The contract you and the seller sign is known by various names, including "contract for deed," "contract of sale," "land sale contract," or "installment sales contract."

The installment arrangement works like this: The contract states that the seller will keep title to the property until you pay off the loan. (You normally pay the loan off in a series of regular payments, similar to a standard mortgage.) After you do so, the seller signs a deed transferring title to you. Because the seller keeps the title over the life of the loan, you cannot sell or refinance the property until all payments are made and the title is transferred--an obvious reason for the unpopularity of this contractual arrangement.

Buying a home with seller financing is not without risk, however, which you'll want to look into further.