Why It Matters
When a seller offers a purchase-money mortgage, you sign a promissory note and they hold a lien on the property until you pay it off. You pay directly to the seller — no bank underwriting, no appraisal, no 45-day closing. Terms are fully negotiated: rate, whether it's interest-only or amortizing, and when the balloon comes due. Most PMMs run three to seven years, with a balloon you retire through refinancing or a sale. The structure opens the door today; the balloon forces your exit strategy later. Plan for both before signing.
At a Glance
- Who lends: The seller — not a bank, credit union, or private lender
- Core documents: Promissory note (the debt obligation) + mortgage deed (the lien on property)
- Typical term: 3-7 years, often with a balloon payment at maturity
- Interest rate: Negotiated — typically prime + 1-3%, or a flat agreed rate
- LTV: Seller's discretion — can range from 80% to 100% of purchase price
- Why sellers do it: Installment sale tax deferral, interest income above CD rates, faster close, moves a hard-to-finance property
- Key risk for buyer: Balloon refinance risk — if credit or market conditions haven't cooperated by maturity, refinancing may be impossible
Monthly Interest-Only Payment = Loan Amount × Annual Rate / 12
How It Works
The seller steps into the lender's role. Instead of a full cash payout at closing, the seller takes a down payment and a promissory note for the balance, holding a recorded lien until paid off. If the buyer defaults, the seller forecloses — the buyer takes the deed at closing, but the seller retains the right to reclaim it.
Interest-only versus amortizing. Many PMMs are interest-only — every payment covers only interest, and the full balance remains outstanding until the balloon. On a $280,000 note at 8%, the buyer still owes $280,000 on day one of year six. Know which structure you're signing.
Why the seller benefits. Seller carryback deals use installment sale treatment — the seller recognizes capital gain only as principal arrives, spreading the tax bill across the note's term. The interest income also exceeds savings account rates, making the PMM a productive exit for sellers who don't need cash immediately.
When conventional financing won't work. Seller financing fills the gap. Properties with deferred maintenance, asbestos, or non-residential zoning routinely fail conventional underwriting. Self-employed buyers and credit rebuilders often have the cash flow to perform but can't satisfy documentation requirements. The PMM connects motivated sellers with capable buyers the banking system has sidelined.
Real-World Example
James finds a vacant commercial property at $380,000. Empty two years, asbestos in the ceiling tiles — no conventional lender will touch it. The seller inherited it and wants out. James negotiates: $350,000 purchase price, $70,000 down (20%), seller carries $280,000 at 8% interest-only for five years.
Monthly payment: $280,000 × 8% / 12 = $1,867/month
He remediates the asbestos ($47,000) and leases to a light-industrial tenant at $4,200/month. After expenses, NOI runs $2,900/month.
Monthly cash flow: $2,900 − $1,867 = $1,033/month
Year five: the property appraises at $480,000. James refinances at 70% LTV:
Refi proceeds: $480,000 × 70% = $336,000
He pays off the $280,000 balloon, nets $56,000 minus closing costs, and converts to a conventional loan at a lower rate.
Pros & Cons
- Closes deals conventional financing won't touch. Properties with condition issues or zoning quirks that fail bank underwriting are fair game with a PMM
- Speed. Close in days — no appraisal, no underwriting queue
- Fully negotiable terms. Rate, amortization, balloon date, and prepayment penalties are all on the table
- Access for non-bankable buyers. Self-employed borrowers and credit rebuilders can acquire properties while their conventional eligibility catches up
- Seller tax benefit. Installment sale treatment spreads capital gains recognition across the note's term
- Balloon risk. If your credit or the market hasn't cooperated by balloon date, refinancing may be impossible — sellers can and do foreclose
- Higher rates. PMM rates typically run above conventional — access and flexibility come at a cost
- Short terms create pressure. A 3-year balloon leaves little runway for properties needing significant work
- Seller default risk. If the seller has an existing mortgage and stops paying, their bank can foreclose on you even while you're making PMM payments
- No standard documentation. Ambiguous note language creates disputes — a real estate attorney is non-negotiable
Watch Out
Run a title search before closing. If the seller has an existing mortgage, their lender likely has a due-on-sale clause — the full balance becomes due on transfer. Sellers sometimes offer PMMs on encumbered properties without disclosing this. Title insurance and a full title search are non-negotiable before you wire a down payment.
Plan the balloon exit on day one. The balloon is in the note — it's not a surprise. Map your refinance path before signing: what credit profile and LTV will you need? If you can't sketch a realistic route, the balloon will ambush you in year three or five.
Document every term. The promissory note must specify the principal, rate, payment schedule, balloon date, late fees, and default provisions. Record the mortgage deed with the county — an unrecorded lien protects neither party.
Ask an Investor
The Takeaway
A purchase-money mortgage completes deals the conventional banking system would never approve. The seller becomes the bank, terms are negotiable, and closing can happen in days. But the balloon is the central risk — if you can't refinance when it comes due, the seller can foreclose. Use PMMs when the property or your profile makes conventional financing impractical: verify the seller's existing liens, build your balloon exit into the structure from the start, and document every term with an attorney.