June 8, 2009 12:00 am

Offer Financing to Sell Your Home?

In today’s real estate market, while prices and mortgage rates have come down, many potential buyers still cannot qualify for a mortgage. If you’re selling a home, consider becoming the “banker” and hold the mortgage (called a “purchase money mortgage”). This can provide several benefits:

  • Close a sale for a buyer with less than the credit rating needed to obtain a commercial loan.
  • Obtain a higher sale price than you normally could.
  • Obtain a steady (monthly) income stream at rates higher than what you might earn through certificates of deposit, Treasuries, or other safe investments.

Should You Offer Seller Financing?

You must determine whether you are in a position to do so. Generally, owners who do have any outstanding mortgages are in the best position to offer this option to buyers.

If you still have a mortgage on the home and the buyer’s down payment will not be sufficient to pay off the balance, this financing option probably won’t work for you. You usually have to satisfy your existing mortgage when you transfer title to the home.

Impact on Reporting the Sale

When you hold the mortgage, in effect you are making an installment sale. You can and should, however, opt to report the entire gain from the sale of your home in the year of sale. Most likely, you will be able to exclude the gain using the home sale exclusion ($250,000 for singles and $500,000 on a joint return). To qualify for the exclusion, you must have owned and used the home as your principal residence for 2 out of 5 years preceding the date of sale.

What Interest Rate to Charge

It is common practice for a seller to charge a higher rate than a buyer could otherwise obtain through a commercial lender. After all, you’re taking a risk. For example, if the usual 30-year fixed rate is 6%, a seller, a private party, can easily charge 8%, 9%, or more. You may want to limit the mortgage term to 15 years or some other period shorter than 30 years.

Under special minimum interest rules, you must charge a certain amount of interest to avoid phantom interest (being taxed on interest you never actually receive). If you fail to charge this minimum amount, then the sale price is allocated to account for the interest that should have been charged. For example, say you sell your home for $200,000 and the interest that would have accrued over the term of the mortgage was $10,000. In this situation, you would report $10,000 of interest income even though you never actually receive separate interest payments.

The interest rate to charge depends on the term of the loan; these IRS-set rates change monthly. In June 2009, the IRS-set rate (called the applicable federal rate or AFR) for a long-term loan (any loan running more than 9 years) was only 3.88%. To rely on the AFR, you can use the lowest applicable rate in effect during the 3-month period ending with the month of sale.

Note: Special minimum interest rules apply to land sales between family members and sales of farms over $1 million.


If you hold the mortgage and the buyer defaults, you can foreclose on the mortgage and recover your property. Repossession has tax implications: You must figure your gain (or loss) on the repossession.

If you resell the home within 1 year after you repossess it, then the original sale and the resale are treated as one transaction. You refigure the amount realized on the sale and combine the selling price of the resale with the selling price of the original sale.

Then subtract from the total any selling expenses, repossession expenses, and the part of the original installment obligation that was unpaid at the time of repossession. Then subtract the basis of the home to determine that gain on the combined sale-resale; the exclusion can them be applied to the net amount.

Word of Caution

If you want to finance the sale in whole or in part, be sure to work with a knowledgeable attorney. The attorney can draft the mortgage and note and record them in the public records so you are protected in case the buyer defaults.

Tax Glossary

Appreciation in value

Increase in value of property due to market conditions. When you sell appreciated property, you pay tax on the appreciation since the date of purchase. When you donate appreciated property held long term, you may generally deduct the appreciated value.

More terms