Seller financing terms on a rental, term by term

The terms on a seller financing deal

Price. Seller financing changes what a price is worth. A seller who gets a monthly income and interest may take a lower down payment or a lower rate in exchange for a higher price, or the reverse.

Down payment. The cash you pay at closing. The rest of the price becomes the note. A bigger down payment lowers the payment and the balloon, and it gives the seller more protection if you stop paying.

Interest rate. The rate on the note. It is negotiated, not set by a bank, but it still has to clear the IRS minimum for seller-financed sales, covered below.

Amortization. The schedule the payment is figured on, such as 30 years. A longer schedule lowers the payment but pays the balance down slowly.

Interest-only period. Some notes charge only interest for the first year or two. The payment starts lower and jumps when principal payments begin.

Balloon date. Many seller notes are figured on a long schedule but come due much sooner, often after a few years. Whatever is left then is the balloon, and you usually pay it by refinancing with a lender or by selling.

The rest of the note. Late fees and grace period, whether you can prepay without a penalty, who pays property taxes and insurance and whether they are escrowed, whether the note can be assumed or sold, and what happens on default. These do not change the payment, but they change your risk.

Formula

Amount financed = price − down payment.

Monthly payment = amount financed × r ÷ (1 − (1 + r)^−n), where r is the annual rate ÷ 12 and n is the amortization in months. During an interest-only period the payment is simply amount financed × r.

Balloon = the balance left after the last regular payment before the due date. Each month, the interest is the balance × r and the rest of the payment reduces the balance.

DSCR on the note = annual NOI ÷ (monthly note payment × 12). NOI is rent minus vacancy and operating costs such as taxes, insurance, repairs, and management, before any loan payment.

Example

Illustrative example. These are made-up numbers to show the math, not a quote, a rate offer, or a market average. An investor buys a rental house for $240,000 with seller financing. The terms: $24,000 down (10%), a $216,000 note at 6.5%, amortized over 30 years, with a balloon due after 5 years.

The payment is about $1,365 a month. After the 60th payment the balance is about $202,200, and that is the balloon. Over the five years the investor pays about $68,116 of interest and only about $13,800 of principal. Counting the down payment, every payment, and the balloon, the seller collects about $308,116.

Now the rent. Say the house rents for $2,100 a month and taxes, insurance, repairs, vacancy, and management take $700, leaving NOI of $1,400 a month, or $16,800 a year. The note costs about $16,383 a year, so the DSCR on the note is about 1.03. The deal barely covers its payment, with roughly $35 a month left before any surprise. That 1.03 is intentionally tight: a risk illustration, not a target to underwrite to.

How each term moves the same deal

Illustrative example. Every change below starts from the $240,000 deal above and changes one term.

A 7-year balloon instead of 5. The payment stays about $1,365. The balloon falls to about $195,299 and you get two more years before you must refinance, but you pay about $93,982 of interest over the seven years.

Interest-only for the first 2 years. The payment starts at $1,170, which lifts the DSCR to about 1.20 for two years. In month 25 it jumps to about $1,398, because the principal is now paid over the remaining 28 years, and the DSCR drops to about 1.00. The balloon at year 5 is higher, about $206,982.

20% down instead of 10%. Putting $48,000 down cuts the note to $192,000, the payment to about $1,214, and the balloon to about $179,733. It costs $24,000 more cash at closing.

Price vs terms: a higher price at a lower rate

Illustrative example. Suppose the seller counters: a $255,000 price at 5% instead of $240,000 at 6.5%, with the same $24,000 down and 5-year balloon. The note grows to $231,000, but the payment falls to about $1,240 and the DSCR rises to about 1.13. The seller collects about $310,528 over five years, more than the first offer.

The catch is the balloon. It rises to about $212,124, roughly $9,925 more than the first offer. If the refinance lender caps the loan at 75% of value, an assumption for this example, the house has to appraise for about $282,832 to pay it off, instead of about $269,600. A higher price can buy a better payment today at the cost of a harder refinance later.

The balloon refinance test

Most balloon notes are paid off with a new loan. That loan will be underwritten on the value, the rent, and the rate at that time, not today. Run the test before you sign.

Value. Divide the balloon by the loan-to-value the refinance lender allows. In the first example, $202,200 ÷ 75% is about $269,600, so the house must be worth at least that in year 5, plus enough to cover refinance closing costs or you bring cash.

Income. Price the new loan at a rate you can live with if rates rise. At an illustrative 7% on a 30-year schedule, $202,200 costs about $1,345 a month, a DSCR of about 1.04 on the same $16,800 NOI. If a DSCR lender in year 5 wants more than that, you need higher rent, a smaller balance, or cash.

If either test fails, negotiate before closing: a later balloon, an option to extend for a fee, a bigger down payment, or a schedule that pays down more principal.

The paperwork: note and deed of trust, or a land contract

In the common setup, the deed goes to you at closing. You sign a promissory note to the seller and a mortgage or deed of trust that lets the seller foreclose if you default. The seller is a lender; you are the owner.

In a land contract, also called a contract for deed, the seller keeps legal title until you finish paying, and you get possession and the right to the title. States treat these very differently, and some add special protections or requirements. Ask an attorney which form fits your state and the deal before you sign either one.

Rules to check: due-on-sale, lending rules, and taxes

Due-on-sale. Federal law (12 U.S.C. 1701j-3) lists a few transfers of a 1- to 4-unit home where a lender may not enforce a due-on-sale clause, such as a transfer to a spouse or into a living trust. A sale to an investor is not on that list. If the seller still has a mortgage, a carryback on top of that loan is a wraparound, and that lender can still call its loan. See the wraparound and subject-to guides before you go that way.

Lending rules when the buyer will live in the home. Regulation Z's consumer rules can apply. A seller who finances three or fewer properties in 12 months is excluded from the federal "loan originator" definition only if, among other conditions, the note is fully amortizing (no balloon), the rate is fixed or first adjustable after five or more years, and the seller makes a good-faith ability-to-repay check. A natural person, estate, or trust that finances only one property in 12 months has a different exclusion: a balloon is allowed if the loan does not negatively amortize, and an ability-to-repay check is not required. These loan-originator exclusions are for consumer credit. Official Interpretation 3(a)-4 generally treats credit to buy a non-owner-occupied rental as business-purpose credit, so Regulation Z generally does not apply to this guide's rental example.

State licensing. State mortgage-licensing rules, including those that implement the SAFE Act, can be tighter than these federal exemptions. This is not legal advice. Have an attorney check your state's rules before you sign.

Taxes. A seller who gets at least one payment after the year of sale can often report the gain on the installment method as payments come in, according to IRS Publication 537. The note must carry adequate stated interest, tested against the IRS applicable federal rates, or part of the principal is treated as interest. Interest the seller collects is ordinary income. The installment method does not apply to real property held for sale to customers in the ordinary course of business, so a flipper carrying a note on a flip should ask a tax professional how the sale will be taxed.

Common pitfalls

Judging the deal by the payment alone. A low payment on a long schedule with a short balloon leaves most of the balance due in a few years. Look at the balloon as hard as the payment.

Skipping the refinance test. If the value, the rent, or the rate in year 5 does not support a new loan, the balloon can force a sale on the seller's timeline or a default.

Assuming the seller owns the house free and clear. Ask, and confirm with a title search. A carryback behind the seller's existing mortgage is a wrap, with due-on-sale risk for both of you.

Forgetting the interest-only jump. The DSCR that looks fine in year one can drop to break-even when principal payments start.

Leaving taxes and insurance unassigned. Write down who pays them, how the seller confirms they are paid, and what happens if they lapse.

Treating a handshake as a note. Use written documents reviewed by an attorney or title company and record the security instrument.

Run your own numbers

The seller financing calculator takes the price, down payment, rate, amortization, balloon year, and any interest-only years, then shows the payment, the balloon, total interest, total paid to the seller, and the year-by-year schedule. Put the payment into the DSCR calculator or the rental cash flow calculator with your own rent and expenses, then price the balloon refinance in the investment property mortgage calculator at a rate you would accept.

These pages run the math on numbers you enter. They do not set loan terms, and nothing here is a loan offer, legal advice, tax advice, or financial advice. Seller financing rules vary by state and by whether the buyer will live in the home, so have a real estate attorney and a tax professional review the deal before you sign.

Sources

Internal Revenue Service, Publication 537, Installment Sales (accessed November 10, 2026), https://www.irs.gov/publications/p537. Defines an installment sale, the installment method, adequate stated interest and the test rate based on applicable federal rates, ordinary-income treatment of interest, and the dealer-sales exclusion for real property held for sale to customers.

Internal Revenue Service, Applicable Federal Rates (accessed November 10, 2026), https://www.irs.gov/applicable-federal-rates. The monthly AFR tables used for the interest test.

12 U.S.C. 1701j-3, Preemption of due-on-sale prohibitions (Garn-St Germain Act), Legal Information Institute (accessed November 10, 2026), https://www.law.cornell.edu/uscode/text/12/1701j-3. Subsection (d) lists the transfers on homes of fewer than five units where a lender may not enforce a due-on-sale clause.

12 CFR 1026.3, Exempt transactions, eCFR (accessed November 10, 2026), https://www.ecfr.gov/current/title-12/chapter-X/part-1026/subpart-A/section-1026.3. Regulation Z does not apply to credit extended primarily for a business, commercial, or agricultural purpose, or to credit extended to other than a natural person.

12 CFR 1026.36(a)(4) and (a)(5), seller financer exclusions from the loan originator definition, eCFR (accessed November 10, 2026), https://www.ecfr.gov/current/title-12/chapter-X/part-1026/subpart-E/section-1026.36. The three-property exclusion requires fully amortizing financing, a good-faith ability-to-repay determination, and a fixed rate or one adjustable only after five or more years. The one-property exclusion covers a natural person, estate, or trust that finances one property in 12 months: a balloon is allowed if the loan does not negatively amortize, and an ability-to-repay determination is not required. Both exclusions apply to consumer credit.

12 CFR Part 1026, Supplement I (Official Interpretations), comment 3(a)-4, eCFR (accessed November 10, 2026), https://www.ecfr.gov/current/title-12/chapter-X/part-1026/appendix-Supplement%20I%20to%20Part%201026. Credit to acquire, improve, or maintain rental property that is not owner-occupied is deemed business-purpose credit.

Every dollar figure on this page is our own illustrative math from the seller financing calculator's formula, not a market survey.

Steps

1. Confirm the seller can carry a note

   Ask whether the property is owned free and clear. If the seller still has a mortgage, a sale usually lets that lender call the loan, so the plan has to pay it off or deal with it in writing first.

2. Write down all six terms

   Price, down payment, interest rate, amortization years, any interest-only years, and the year the balloon is due. Add late fees, prepayment rules, and who pays taxes and insurance.

3. Run the note

   Calculate the monthly payment, the balance due at the balloon, the interest you pay before it, and the total the seller collects.

4. Test the payment against the rent

   Subtract operating costs from the rent to get NOI, then divide by the note payment. A ratio near 1.0 means almost nothing is left after the payment.

5. Test the balloon refinance

   Work out the value and the income a new lender would need to pay off the balloon. Use a rate higher than today's in case rates rise.

6. Have the paperwork reviewed

   Before you sign, have a real estate attorney or title company check the note, the security instrument, the due-on-sale question, and your state's rules.

Questions