What it means
In the usual form, the seller agrees to take back part of the price as a loan. The buyer signs a promissory note, which is a written promise to repay, and a mortgage that gives the seller a claim on the property if the buyer stops paying.
The term can also describe any mortgage whose proceeds are used to buy the property it secures. In many places the purchase money mortgage has priority over other debts against the buyer because it was created at the same moment as the purchase.
Sellers offer this kind of financing for several reasons. It widens the pool of possible buyers, can speed up a sale in a tight credit market and gives the seller a stream of interest income as well as the price.
The terms are negotiated directly. The deposit, interest rate, repayment period and any balloon payment, which is a large final instalment, are all agreed between buyer and seller and written into the contract.
The risks differ for each side. The buyer may pay a higher interest rate than a bank would charge and may face a balloon payment that is hard to refinance, while the seller carries the credit risk and may have to go through legal steps to recover the property if the buyer defaults.
The nuance is that rules vary widely by location. Consumer protection laws, licensing requirements and limits on foreclosure can apply, so both sides should obtain legal advice before agreeing terms.
In practice
Real-world examples.
Example
A retiring shop owner sells her premises for $450,000 to a younger manager who cannot obtain a bank loan for the full amount. The manager pays $90,000 up front and the owner finances the balance. The owner receives monthly payments that supplement her pension.
Example
A family selling a farm agrees a purchase money mortgage with a neighbouring grower over ten years. The interest rate is slightly above the bank rate, and the deal includes a balloon payment at the end. The grower plans to refinance with a bank once the farm's income is proven.
Example
A property developer sells a block of flats and takes back a second mortgage for part of the price to close the deal. The accountant records the loan as a receivable and recognises interest income each month.
Formula
Calculation
Monthly payment = loan x r / (1 - (1 + r)^(-n)), where r is the monthly interest rate and n is the number of payments
Suppose a buyer pays $300,000 for a building, puts down 20% ($60,000) and the seller finances the remaining $240,000 at 6% a year over 30 years. The monthly rate is 0.06 / 12 = 0.005, and there are 12 x 30 = 360 payments. (1.005)^360 is about 6.0226, so 1 / 6.0226 = 0.16604 and 1 - 0.16604 = 0.83396. Payment = 240,000 x 0.005 / 0.83396 = 1,200 / 0.83396 = $1,438.92. Over 360 payments the buyer repays 1,438.92 x 360 = $518,011, so total interest is 518,011 - 240,000 = $278,011.Case study
Seen in the real world.
Maple Lane Builders is an illustrative, fictional construction company that wished to sell a finished office building during a period when banks were reluctant to lend. A small accounting firm wanted the space but could secure only 60% of the price from its bank.
The builder's finance director proposed a purchase money mortgage for another 20% of the price, secured by a second charge on the building. She calculated the monthly receipts, the interest income and the worst case in which the buyer defaulted.
The accounting firm completed the purchase and made payments on time, and the builder sold the loan to an investor after two years. The illustrative lesson is that offering finance can close a sale, but it turns the seller into a lender who must manage the credit risk.
Watch out
Common mistakes.
- Skipping a credit check on the buyer, when the seller is taking on the same default risk as a bank would.
- Agreeing a balloon payment without a plan to refinance, which can leave the buyer unable to pay when it falls due.
- Failing to record the mortgage officially, which can weaken the seller's legal claim against the property and other lenders.
Questions
People also ask.
Is a purchase money mortgage always seller-financed?
Not always, because the term can also describe any loan used to buy the property that secures it, although seller financing is the usual meaning.
Who has first claim if the buyer defaults?
It depends on the order in which loans are registered, and a purchase money mortgage often ranks ahead of other debts against the buyer, though a prior bank mortgage on the property may rank higher.
How does the seller account for the loan?
The seller records a receivable for the unpaid balance and recognises interest income over time as payments come in.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%