Owner Financing When You Sell a House in Indiana or Kentucky

Who this guide is from: Mortgage Forfeiture is Roger Choate's local direct home-buying business serving Southern Indiana and the Louisville metro. Informational guides are general education; legal, tax, lending, and court decisions should be reviewed with the appropriate licensed professional.

You can sell a house with owner financing in Indiana or Kentucky. Neither state prohibits it. Before you do, three things decide whether it is a good idea for you: which federal seller-financer exclusion you fit, what happens if the buyer stops paying, and whether you can afford to wait years for your money.

This guide walks through the rules with links to the statutes. It is not legal or tax advice. Have an attorney draft the paperwork and a tax professional review the numbers before you sign anything.

Three ways to carry the sale, and how they differ

People use "owner financing," "land contract" and "rent to own" as if they were the same thing. They aren't, and the difference decides what happens when something goes wrong.

Owner financing with a note and mortgage

The buyer signs a promissory note and gets the deed at closing. You record a mortgage against the house to secure the note. In both states the usual instrument is a promissory note secured by a recorded mortgage. If the buyer defaults, you foreclose the way a bank would.

Land contract (contract for deed)

You keep the deed until the buyer pays in full. The buyer gets possession and an equitable interest. Sellers often assume this makes removal easy on default. In Indiana and Kentucky it doesn't, as explained below.

Lease with option to buy (rent to own)

The buyer rents the house and holds an option to purchase at a set price within a set time. Whether a particular lease option is treated as a sale, a loan or a lease depends on how it is written. Ask an attorney before you call anything "rent to own."

The federal rule that decides whether you are a loan originator

Regulation Z treats a person who extends consumer credit secured by a dwelling as a loan originator unless an exclusion applies. Two exclusions are written for sellers who finance their own property, and they are not the same. The text is in 12 CFR 1026.36(a)(4) and (a)(5).

One property in any 12 months

This exclusion is only for a natural person, an estate or a trust. You must not have built the home in the ordinary course of business. The financing cannot negatively amortize, and the rate must be fixed, or adjustable only after five or more years with reasonable annual and lifetime caps tied to a widely available index. This exclusion does not require you to verify the buyer's ability to repay, and it does not bar a balloon payment.

Three or fewer properties in any 12 months

This one covers any person, including an LLC, that finances three or fewer properties it owns in a 12-month period. The same builder and rate conditions apply. Two conditions are stricter: the financing must be fully amortizing, which rules out a balloon, and you must determine in good faith that the buyer has a reasonable ability to repay.

Fall outside both exclusions and you are a loan originator under federal law, with the licensing, compensation and disclosure rules that come with that. Getting the rule wrong can expose you to federal and state penalties and to claims by the buyer. Have an attorney confirm which exclusion you fit before you sign.

State licensing is a separate question

The SAFE Act is enforced through state mortgage licensing laws, and the federal exclusions above do not automatically answer the state question.

• Indiana licenses mortgage loan originators through the Department of Financial Institutions under IC 24-4.4. The exemption list includes an individual financing a dwelling that served as the individual's own residence and an individual helping an immediate family member. Whether a one-time seller-financed sale of another property needs a license is a question for DFI or an attorney.
• Kentucky lists its exemptions in KRS 286.8-020. One covers an entity other than a natural person that makes no more than four mortgage loans a year with its own money on residential property it owns, without intending to resell the loan and without holding itself out as a mortgage lender. Ask the Kentucky Department of Financial Institutions or an attorney whether an individual seller needs a license.

Kentucky's real estate brokerage law is a different statute. An owner selling property he or she owns is exempt from the broker licensing requirement under KRS 324.030. That exemption is about brokerage, not lending.

If you still owe on the house

Most mortgages contain a due-on-sale clause. Federal law, the Garn-St Germain Act at 12 U.S.C. 1701j-3, lets the lender enforce that clause when you transfer the property, with limited exceptions such as a transfer to a spouse or child, a transfer on death, or a transfer into a living trust where you stay the beneficiary. Selling with owner financing while your own loan stays in place, sometimes called a wrap, is a transfer. The lender can call the whole balance due. The buyer's payments don't protect you from that, and the buyer's title is only as good as your continued ability to pay your lender. Talk to your lender and an attorney before you consider a wrap.

Recording and disclosures

In Indiana, deeds, mortgages, land contracts and memoranda of land contracts must be recorded in the county recorder's office, and they take priority by the time of recording (IC 32-21-4-1). An unrecorded mortgage or contract leaves you exposed to a later buyer or lender who records first. Kentucky lets contracts for the sale of real property be recorded as well (KRS 382.100). Use a title company or attorney to close and record.

Indiana's seller disclosure form applies to a sale, an exchange, an installment sales contract or a lease with option to buy of residential property with up to four units, and the buyer must have it before an offer is accepted (IC 32-21-5). Kentucky's seller disclosure form applies to single-family sales in which a licensed agent is compensated (KRS 324.360). Disclose known problems in writing either way; it protects you later.

When the buyer stops paying

This is the part sellers underestimate. In both states, getting the house back is a court process.

Indiana

Indiana foreclosure is judicial. Under IC 32-29-7-3 the sheriff's sale cannot be ordered until at least three months after the complaint is filed, unless the court finds the property abandoned, and the case itself can take longer. Indiana courts treat a land contract seller as a lienholder. Under Skendzel v. Marshall (Ind. 1973), the normal remedy for a buyer's default is foreclosure of the contract, not forfeiture; forfeiture is reserved for narrow cases such as a buyer who abandons the property or has paid very little. There is no fixed percentage in a statute. Ask an Indiana attorney how your contract would be enforced.

Kentucky

Kentucky foreclosure is judicial too. The seller files suit, the court orders the sale and a master commissioner sells the property (KRS Chapter 426). For land contracts, the Kentucky Supreme Court held in Sebastian v. Floyd (Ky. 1979) that a forfeiture clause is unenforceable and the seller's remedy is a judicial sale of the property. No timeline is promised here; ask Kentucky counsel.

While the case runs, you are paying the attorney, the house may be deteriorating, and the taxes and insurance still come due. Build that into your decision.

Taxes on an owner-financed sale

A sale with at least one payment after the year of sale is an installment sale under IRS Publication 537. Four points matter most:

• You generally report gain as payments arrive, on Form 6252, instead of all at once.
• The interest you collect is ordinary income.
• If the contract charges little or no interest, the IRS treats part of each payment as interest anyway, measured against the applicable federal rate. Set the rate with that in mind.
• Property held for sale to customers in a business does not qualify, and any depreciation recapture is reported in the year of sale even if you have not been paid yet.

Have a tax professional run your numbers before you decide. The spread-out reporting helps some sellers and does nothing for others.

What you take on as the lender

• Checking the buyer's income, debts and credit, and documenting it, which the three-property exclusion requires.
• Collecting payments, tracking escrow for taxes and insurance, and sending year-end interest statements, or paying a servicer to do it.
• Making sure hazard insurance names you as loss payee and the taxes are paid, because the house is your only security.
• Waiting years for the balance, with no sure way to sell the note at full value.
• Foreclosing in court if the buyer stops paying, and taking the house back in whatever shape it is in.

If you still want to carry the note

1. Hire a real estate attorney in the state where the house sits. The note, mortgage or contract and the disclosures have to match that state's law and the federal exclusion you are using.
2. Count your seller-financed sales in the last 12 months. That count decides which exclusion applies and whether a balloon is allowed.
3. Talk to your own lender first if there is a mortgage on the house.
4. Screen the buyer like a lender would and keep the file.
5. Record the mortgage or contract at the county recorder the day you close.
6. Get tax advice on the installment reporting and the interest rate before you set terms.

What this means if you need to sell

Most owners who look at owner financing are trying to solve a different problem: the house will not sell the normal way, or they need it gone. Roger Choate buys houses directly, as-is, in Louisville and Southern Indiana. He reviews the property and the records, then puts a written offer in front of you. If you accept, a title company handles the closing and you pick the date, subject to title and payoff. There is no seller company fee or agent commission. Your mortgage payoff, liens, taxes, prorations and other settlement items still come out of the price and show on the settlement statement.

A direct sale removes buyer-financing and inspection contingencies. It does not remove title, lien, payoff, probate, court, lender or signature requirements, and no closing date is guaranteed. To see how a direct offer stacks up against a listing or carrying the note, read compare your options and how it works. Roger buys in Jeffersonville and Southern Indiana and in Louisville and the surrounding Kentucky counties.

Frequently asked questions

If you would rather have a written number to compare against carrying the note, call (502) 528-7273 or Get My Cash Offer.