Seller financing is NOT a loan. It is more accurately described as “the terms of the sale”. Many an Attorney, Realtor, and their Broker will argue that it is indeed a loan. They are wrong. Let me explain.
First, let’s begin with a couple of definitions and descriptions.
– Purchase Money Mortgage: A mortgage pledging collateral (most usually the subject home) to
secure a Purchase Money Note.
– Purchase Money Note: A Note promising payment (also commonly called a Note)
– Mortgage: A pledge of collateral (most usually the subject home) to secure a Note.
– Promissory Note: A note promising re-payment (also commonly called a Note)
The confusion centers on the Purchase Money Note and Promissory Note being used interchangeably. They are NOT the same.
Let’s walk through 2 transactions to illustrate the danger of interchanging the two:
Transaction 1: Buyer wants to buy home. Agreed upon price is $100,000. Buyer does not have $100,000 in bank account. Buyer goes to a bank (3rd party to the transaction) to get a loan. At closing, bank gives $100,000 to the Buyer; Buyer then gives the Seller $100,000, Seller then transfers to Buyer the Title/Deed to property. Buyer promises to re-pay the bank (see where this is going?) by signing a Promissory Note and also pledging the home as collateral (Mortgage) in the event he does not re-pay the bank.
Moral: The Buyer borrows (gets a loan) from a 3rd party (bank) to complete the transaction. With the loan, money (in this case $100,000) is exchanged.
Transaction 2: Buyer wants to buy home. Agreed upon price is $100,000. Seller agrees to the following terms: Seller financing at the rate of $1,000 per month for 100 months. At closing Seller transfers Title/Deed to Buyer, Buyer promises to pay (not “re-pay”) Seller via a Purchase Money Note. The Purchase Money Note is then secured by a Purchase Money Mortgage which pledges the home as collateral.
Question: How can you “re-pay” a Title/Deed transfer? Answer: You can’t. You can re-transfer the property, but you can’t re-pay a transfer of ownership. (It was a trick question). If your Attorney, CPA, Realtor, or Brother-in-Law can’t grasp this concept, get a better Attorney, CPA, Realtor or Brother-in-Law…
Moral: The Buyer and Seller transfer Title/Deed. What is exchanged is a promise to pay (not re-pay).