A private mortgage is a home loan funded by an individual or non-bank source rather than a traditional lender. Most are family-to-family loans, seller-financed deals, or loans from small private investors. This guide walks both sides through 11 setup steps: the federal rules that quietly apply, the IRS rate you cannot undercut, and the exit plan to write before closing.
It seems like getting a private mortgage should be easier than using a bank. There's no committee, no underwriter, and no mountain of paperwork. Terms are agreed upon, a few documents are signed, and that's it. Fortunately, this is largely accurate: a private mortgage offers greater flexibility than a conventional loan. The problem is that in a private transaction, the safeguards that a bank automatically incorporates, such as clear title work, regulated disclosures, and predictable servicing, do not show up on their own. They must be created by hand.
The 11 stages below cover the same setup work whether you are a buyer working with a small private investor, a seller holding a note instead of cashing out at closing, or a parent assisting a child in purchasing their first property. An IRS floor must be cleared by the interest rate. To enforce, the notice must be drafted. It is necessary to record the mortgage. The loan must be repaid by someone. At the end of the year, both parties must disclose it to the IRS. That's not difficult at all. It must all genuinely occur.
One reason this is more important now is that more buyers and sellers are looking at private finance as a workaround because the average 30-year mortgage rate has been in the 6% area for a number of years. Are grandparents considering financing a first house, or are parents considering loan children a down payment? The adaptability is genuine. The safeguards don't happen automatically. This is what needs to be done before the initial payment is made.
Before any of the paperwork makes sense, you need to know which kind of private mortgage you are actually setting up. The term covers a few different transactions that share one feature: the lender is not a bank or a licensed mortgage company. Beyond that, almost everything else, including the rules that apply, the rate the IRS expects, and the documents you will need, depends on the relationship between the lender and the borrower.
Three patterns cover almost all private mortgages.
The first is seller financing, where the seller of the home becomes the lender and the buyer pays them directly instead of going to a bank. This usually shows up when the property has a feature traditional lenders do not like, such as unconventional construction or mixed use, or when the seller owns the property free and clear and prefers ongoing income to a lump sum.
The second is family lending, where a parent, grandparent, sibling, or other relative funds the purchase, either fully or as a second loan layered behind a smaller traditional mortgage. The motivation is usually rate, since a family member can offer below-market terms, or qualification, when the borrower cannot get approved for the amount they need.
The third is private investor lending, where an individual or small group funds the loan as a yield-generating investment. This might be a real estate investment club, a hard-money lender, or a single high-net-worth individual. This pattern tends to come with shorter terms, higher rates, and more aggressive default remedies than the other two.
Each setup triggers slightly different federal rules and tax treatment, so step 1 is to be honest about which one you are in. A seller carrying back a small second behind a traditional first is a different transaction than parents funding the whole purchase, and the paperwork has to reflect that. AmeriSave's loan officers see all three patterns regularly, often as the takeout when a borrower comes back to refinance the private loan into a conventional mortgage once they qualify.
The majority of private mortgages omit this step, which increases the likelihood of future legal risk. More frequently than not, private transactions are subject to federal lending regulations.
Anyone who frequently offers consumer loans secured by a home is considered a creditor under the Truth in Lending Act and Regulation Z, and they must abide by disclosure standards, ability-to-repay guidelines, and other safeguards. The frequency threshold is established by the Consumer Financial Protection Bureau, which drafts and implements Regulation Z. A person or organization is often considered a creditor and is subject to the entire set of rules if they have extended consumer credit secured by a residence more than five times in the previous calendar year. Most one-time private transactions fall outside the creditor definition below that cutoff.
The SAFE Act establishes minimal requirements for state licensure of mortgage loan originators and is enforced by the Consumer Financial Protection Bureau through Regulation H. (The Dodd-Frank Act shifted administration from HUD to the CFPB.) States execute these regulations differently, although sellers who occasionally finance the sale of their own homes typically do not fall under the loan-originator classification. Licensing is typically triggered by continuous or large-scale seller-financing operations rather than a few financed sales per year by an individual, estate, or trust.
Ability-to-repay regulations were among the additional safeguards established by the Dodd-Frank Act. Two specific seller-financing exceptions are carved out by Regulation Z, and both prevent the seller from being regarded as a loan originator. A natural person, estate, or trust that finances just one property during a 12-month period is covered by the more accommodating version, which permits balloon payments. Any seller (including entities) who funds three or fewer homes in a 12-month period is covered by a distinct exception, but the conditions are more stringent: the financing must be fully amortizing with no balloon, and the seller must judge in good faith that the borrower can repay.
Because AmeriSave functions as a licensed mortgage lender under these same federal standards, borrowers converting a private loan into a conforming product enter a regulated setting with built-in disclosures and protections. Before any documentation is sent out, a real estate lawyer with a license in the state where the property is located can verify which exemptions apply.
The interest rate on a private mortgage is the place most family loans go wrong, because the temptation to offer a no-interest or low-interest deal collides with a section of the tax code most people have never heard of.
Internal Revenue Code Section 7872 covers below-market loans. If a loan between a lender and a borrower charges interest below the applicable federal rate published by the IRS, the difference is treated as if the lender gave the borrower a gift equal to the foregone interest, and the lender is treated as having received that interest as income anyway. Both sides of the transaction can owe taxes on income that nobody actually paid.
The IRS publishes the Applicable Federal Rates every month in three tiers based on loan term: short-term for loans of 3 years or less, mid-term for loans over 3 and up to 9 years, and long-term for loans over 9 years. A typical 30-year private mortgage uses the long-term rate. Charging at or above the long-term rate avoids the imputed-interest problem entirely.
A few practical points. The published rate is the floor, not the ceiling. Family lenders often want to charge a rate that is competitive with what a bank would offer, partly to make the deal feel like an arm's-length transaction and partly because that rate is closer to what the borrower would pay otherwise. Investor lenders and hard-money lenders typically charge well above the floor. Seller financers tend to sit between the two, often pegging to a market rate at closing.
State usury laws set an upper bound. Most states cap the maximum interest rate on private consumer loans, and the cap varies widely. Some states cap consumer loans in the high single digits; others allow rates to run higher with proper disclosure. A rate that violates state usury law can void the interest portion of the loan or worse, so confirming the cap before the rate is set is part of the setup. AmeriSave does not price private deals, but its loan officers can sketch what a comparable conforming or non-conforming loan would price at, which is useful as a benchmark.
A private mortgage is a lien against the property. If the title is not clean before the loan funds, the lender has no real security and the borrower has no real ownership.
A title search through a title company or a real estate attorney pulls up everything recorded against the property: existing mortgages, mechanics' liens, judgment liens, tax liens, easements, and any other claim that survives a sale. For a family loan or a seller-financed deal, the cost of a title search is small relative to the size of the loan and is the only reliable way to confirm what the lender is actually getting.
Title insurance is the next layer. An owner's policy protects the buyer against claims that surface after closing. A lender's policy protects the lender against the same. Traditional mortgages require a lender's policy in nearly every transaction. Private mortgages do not, but skipping it leaves the lender exposed if a previously unknown lien shows up later. For a parent lending a child $100,000, the cost of a one-time lender's policy is a small price for sleeping at night.
Property condition matters too. A traditional lender orders an appraisal partly to confirm value and partly to flag obvious defects. A private lender does not have to, but probably should. An appraisal from a licensed appraiser, ordered through an appraisal management company or directly, establishes value at closing and creates a paper trail if the loan ever needs to be refinanced into traditional financing later. A home inspection by a licensed inspector covers the condition side and surfaces issues the appraisal might miss.
For investor-funded loans, this step usually expands. Private investors often want a Phase I environmental review, a survey, and sometimes a structural engineer's report before funding. For a parent lending to a child, the threshold is lower, but skipping basic title and appraisal work is a common mistake that surfaces years later when the borrower tries to refinance into an AmeriSave conventional loan and the title issues come up at underwriting.
A private mortgage actually involves two documents, and both have to exist for the loan to be enforceable.
The promissory note is the IOU. It states the loan amount, the interest rate, the payment schedule, the maturity date, default terms, late fees, prepayment terms, and any acceleration clause that lets the lender demand the full balance if the borrower defaults. The note is the document that gets signed at closing and the document that gets enforced in court if payments stop.
The mortgage or deed of trust is the lien. It is the document recorded with the county recorder's office that puts the world on notice that the property is securing the debt. States use either a mortgage, which is a two-party agreement between borrower and lender, or a deed of trust, which is a three-party agreement involving a trustee who can foreclose without going through court. The choice depends on the state where the property sits, not on what the parties want.
Both documents have to be drafted correctly to be enforceable. A handwritten note between family members might feel sufficient, and it might even be legally valid, but it almost never includes the specific language a court needs to enforce default remedies, and it cannot be recorded as a security interest the way a properly drafted mortgage or deed of trust can. A real estate attorney who routinely drafts loan documents can produce both for a flat fee in most markets.
A few specific provisions to include. Require evidence of homeowner's insurance with the lender named as loss payee. Require evidence that property taxes are being paid. Include a clause requiring the borrower to notify the lender of any senior or junior liens. For family loans especially, include a clear acceleration clause and a defined default cure period. Borrowers and lenders both benefit from knowing exactly what happens if a payment is late, before it happens.
Recording the mortgage or deed of trust with the county is what makes the lien public and senior to anything recorded later. Filing fees are small. Not recording is a common shortcut in family deals that leaves the lender unsecured against later claims.
Servicing is the day-to-day work of running a loan: collecting payments, tracking principal and interest, managing escrow for taxes and insurance, sending statements, and reporting to the IRS at the end of the year. Traditional mortgages have servicing built in. Private mortgages do not, and the gap is the source of most of the headaches that show up years after closing.
Three options are common.
The first is self-servicing. The lender tracks payments directly, usually through a spreadsheet or accounting software, and the borrower sends payments by bank transfer or check. This works for small, short-term family loans where both sides are organized. It breaks down on longer loans, in deals with escrow, or when the lender's heirs eventually inherit the loan and do not know where the records are.
The second is third-party loan servicing. Several companies specialize in servicing private and family mortgages for a setup fee plus a monthly fee, typically a small percentage of the payment amount. They handle the IRS reporting, escrow management, late fee enforcement, and statements. For loans over a few tens of thousands of dollars, this option pays for itself in saved time and avoided errors.
The third is hybrid servicing through the closing attorney or a local title company, which some markets offer for a per-payment fee. This option sits between the first two on cost and reliability.
A few servicing details worth getting right at setup. Decide where payments go and how. Bank transfer creates a clean audit trail; checks do not. Decide whether the loan will escrow for property taxes and insurance, or whether the borrower will pay those directly. Escrowing protects the lender's security interest. Not escrowing puts the responsibility on the borrower and requires the lender to confirm payment annually. Decide how the loan will be amortized: standard amortization with equal payments, interest-only with a balloon, or a custom schedule. Standard amortization is the simplest and the easiest to refinance later through a lender like AmeriSave.
Homeowner's insurance and property taxes are the two ongoing expenses that, if neglected, can wipe out a lender's security interest faster than any default on principal or interest.
Homeowner's insurance protects the property against fire, weather, and liability claims. The mortgage or deed of trust should require the borrower to maintain insurance and to name the lender as loss payee or mortgagee. Naming the lender as loss payee means the lender gets notified if the policy lapses or is canceled, and any insurance check after a loss is made jointly payable to the borrower and lender. Without this clause, a borrower could let coverage lapse, suffer a total loss, and leave the lender holding a worthless lien on a burned-down house.
Property taxes work similarly. If a homeowner stops paying property taxes, the taxing authority can put a tax lien on the property that is senior to any private mortgage. Eventually, the property can be sold at a tax sale, and the private lender gets nothing.
Setup options. The cleanest approach is to escrow for both taxes and insurance, the same way a traditional mortgage does. The borrower pays one-twelfth of the annual amount into the escrow account with each monthly payment, and the servicer pays the bills when they come due. A private mortgage can absolutely include an escrow account, and most third-party servicers offer one as a standard option.
If escrow is not realistic, the next-best option is annual verification. The lender confirms each year, in writing, that taxes are paid current and the insurance policy is in force. This is a clause that goes into the note or into a separate loan covenants document. For small, short-term family loans, it can be informal. For larger or longer loans, it should be a defined requirement with consequences for non-compliance, including the lender's right to pay the bills and add them to the loan balance if the borrower fails to.
Borrowers who later refinance into a traditional loan through AmeriSave or another conforming lender will be required to escrow under most loan programs anyway, so building escrow into the private mortgage from the start makes the eventual transition smoother.
Both the borrower and the lender on a private mortgage have IRS reporting to do, and the rules differ from what applies to a traditional mortgage.
For the borrower, the mortgage interest paid on a private loan is generally deductible on Schedule A as itemized mortgage interest, subject to the same overall mortgage debt limits as bank-funded loans. The Internal Revenue Service requires the loan to be secured by a qualified residence and the proceeds to be used to buy, build, or substantially improve that residence. A private mortgage that meets those conditions qualifies. One quirk: when a traditional lender receives mortgage interest of $600 or more in the course of its trade or business, it files Form 1098 reporting the interest. Private lenders who are not in the business of lending generally do not file Form 1098, which means borrowers have to track their own interest payments and report them correctly on Schedule A.
For the lender, the interest received on a private mortgage is reportable as interest income on Schedule B. Whether the lender files a 1098 depends on whether the lender qualifies as being in the trade or business of lending. Most family and one-off seller financers do not, but the borrower's interest deduction still depends on accurate records, which means the lender effectively has to produce an annual statement showing interest paid even if no IRS form is filed.
For family loans specifically, the imputed-interest rules under Section 7872 require that any difference between the stated interest and the applicable federal rate be reported as interest income to the lender and a gift to the borrower. The lender may owe income tax on interest never actually received, and the gift portion may use up annual gift-tax exclusions or lifetime exemption amounts.
Capital gains treatment of the property sale, if seller financing is involved, can sometimes qualify as an installment sale under Section 453. This spreads the seller's capital gain over the life of the loan instead of recognizing it all in the year of sale. The election has specific requirements and limitations, and a tax professional should run the numbers before closing rather than after.
For both sides, the cost of a tax professional to confirm setup before the first payment is small relative to the risk of getting any of this wrong on a multi-year loan.
A private mortgage works best when both sides agree, in writing, on how the loan ends. The exit strategy is the part most setups skip, and it is the single biggest predictor of whether the arrangement stays good or goes bad.
Three exits cover most situations.
The first is refinance into a traditional mortgage. The borrower qualifies for a conforming loan with AmeriSave or another lender, pays off the private balance, and the lender gets their money back in a lump sum. This is the most common planned exit for family loans and seller-financed first mortgages. It usually has a defined target window built into the note, such as a 5-year balloon that forces the refinance even if rates have not moved favorably.
The second is sale of the property. The borrower sells the home, the private mortgage is paid off from the proceeds at closing, and the lender is released. This exit does not usually require special planning, but the note should clearly include a due-on-sale clause so the loan cannot be assumed by a buyer without the lender's consent.
The third is payoff at maturity. The borrower pays the loan off in full at the end of its term, either through scheduled amortization or through a balloon payment. This is the cleanest exit on paper and the hardest in practice on a balloon, since the balloon payment is often larger than the borrower can produce without a refinance.
Setting up the exit before closing means building specific milestones into the note. A 5-year balloon with an option to extend on stated terms is more workable than a hard balloon with no flexibility. An interest-only period with a defined amortization start date can give the borrower time to build income or repair credit before payments increase. A clear definition of qualifying refinance terms, such as the loan-to-value ratio or credit score required, can help both sides set expectations.
For seller-financed first mortgages especially, the most common scenario is that the borrower eventually refinances through a conforming lender, and AmeriSave loan officers see this pattern frequently as the eventual outcome of a well-structured private loan.
Default scenarios are the conversation no one wants to have at closing, which is exactly why they need to happen at closing.
Three scenarios are worth thinking through in writing.
The first is missed payments. The note should define what triggers default. Common framing is 1 missed payment as a late event with a defined late fee, 2 consecutive missed payments as a notice event, and 3 consecutive missed payments as a default that allows acceleration. A grace period of 10 to 15 days before late fees apply is standard. A cure period of 30 to 60 days after a default notice is standard. The lender's right to accelerate the loan and demand the full balance should be explicit.
The second is foreclosure. State law governs foreclosure procedures, and the procedures vary widely. Roughly 20 states require judicial foreclosure as the primary path, where the lender has to file a lawsuit and get a court order before the property can be sold. Most of the rest allow non-judicial foreclosure, where the lender can foreclose under the terms of a deed of trust without a court proceeding. Non-judicial foreclosure is faster and cheaper for the lender. Judicial foreclosure gives the borrower more procedural protection. The state where the property sits, not the state where the lender lives, determines which applies. For family loans especially, foreclosure is the worst-case scenario nobody wants to use, but having the legal right to foreclose changes the conversation when a missed payment turns into three.
The third is borrower bankruptcy. If the borrower files for bankruptcy, the loan and the property both fall under the bankruptcy court's jurisdiction. A recorded mortgage or deed of trust survives bankruptcy in most cases, but the timing of payments and the right to foreclose are suspended during the automatic stay. An unrecorded loan, or a loan without proper documentation, can be challenged or stripped in bankruptcy. This is the case for getting the recording done correctly at setup.
For family lenders, the hardest part of this step is not legal. It is emotional. Talking through default scenarios with a child or a sibling at the kitchen table feels uncomfortable, but it is much harder to have that conversation after the fact than before.
Verify that a private mortgage is truly the best option. This is the final, and most neglected, step before closing.
Because regular mortgages don't work in every circumstance, private mortgages are available. However, they come at a cost that isn't always immediately apparent: higher rates than traditional loans for investor-funded transactions, less flexibility in refinancing for family loans where the parents anticipate repayment on a predetermined schedule, higher setup costs for legal and administrative fees, and less consumer protection for borrowers who forgo the disclosures and counseling that come with regulated lending.
Obtaining a soft preapproval from a conforming lender, such as AmeriSave, and seeing the results is a helpful practice. Preapproval provides both parties to the private transaction with a genuine baseline to compare against, is free, and does not lock anything in. Once setup expenses, continuing risk, and tax complexity are taken into account, the math typically favors the conventional loan if the borrower can qualify for one at a rate within one or two points of what the private deal would give.
Considering what would happen if the borrower's circumstances changed is a second exercise. loss of employment, divorce, relocation, an unforeseen medical expense, or a death in the family. Forbearance alternatives, loss-mitigation strategies, and government programs that kick in during difficulty are all features of traditional mortgages. Private mortgages don't. What occurs is determined by what is stated in the loan documents.
Thinking about the relationship is the third exercise. Successful family loans typically have formal documentation, actual payments, a clear repayment schedule, and both parties approach the loan as a loan. Failing family loans are typically informal, with ambiguous terms and an unspoken belief that the loan will be forgiven in the event of hardship. This tutorial explains how to formally set up a private mortgage in a way that protects both the relationship and the property.
The 11 stages above are the framework if, after completing this checklist, a private mortgage still makes sense. If it doesn't, the discussion takes a completely another turn when an AmeriSave loan officer illustrates what a conforming or FHA loan will entail.
Although they are both non-bank loans, they fall into separate categories. A hard-money loan is a particular kind of private mortgage that is usually short-term, made at a higher interest rate by a professional lender or investor, and secured by real estate. In a fix-and-flip or bridge transaction, the borrower is typically a real estate investor. The word "private mortgage" refers to a wider range of loans, including seller-financed first mortgages, long-term family loans at moderate rates, and hard-money rehab loans. By purpose, the word, rate, and structure are different.
Yes, most of the time. The promissory note, mortgage, or deed of trust can be drafted by a real estate lawyer licensed in the state where the property is located. They can also verify that the loan conforms with state usury laws and recording requirements and manage the county recording. In comparison to the loan amount and the cost of later correcting a poorly worded loan, the cost is usually a flat fee in the hundreds to low thousands of dollars, depending on complexity. Title firms may be able to manage the closing without an attorney in certain regions, which may be less expensive.
Indeed, it is the most typical way out of seller-financed first mortgages and family loans. A conforming lender replaces the private loan with a normal 30-year or 15-year mortgage when the borrower meets the requirements. The initial private loan must have been properly documented and recorded, and the borrower must satisfy the credit, income, and equity requirements of the conforming lender. These conversions are frequently handled by AmeriSave. A few months before any balloon payments are due, borrowers preparing this exit should initiate the refinance discussion, ensure that the private loan was accurately recorded, and maintain spotless payment records.
Every month, the IRS releases the Applicable Federal Rate in three categories according on the length of the loan: short-term for loans lasting three years or less, mid-term for loans lasting three to nine years, and long-term for loans lasting more than nine years. The long-term rate is applied to a 30-year private mortgage. The floor is the published rate. The imputed-interest regulations under Section 7872 are circumvented by charging at or above the declared rate. Usually revised in the third week of the previous month, the current month's rates can be found on the IRS website under Revenue Rulings.
In general, yes, provided that the loan satisfies the IRS requirements for a qualifying home loan. It must be secured by the borrower's primary or secondary residence, and the funds must be utilized to purchase, construct, or significantly enhance that residence. Subject to total mortgage debt limits, the borrower deducts the interest on Schedule A as an itemized deduction. The borrower must keep track of payments and get a yearly interest statement from the lender to support the deduction because private lenders who are not in the lending industry typically do not submit Form 1098.
Yes, however much like a standard mortgage, the private mortgage typically needs to be paid off at closing. When the private amount is paid off using the buyer's purchase money or the proceeds from the buyer's new mortgage, the lender releases the lien, allowing the title to transfer smoothly. The majority of well-written private mortgages have a due-on-sale clause, which prevents the new buyer from taking over the loan without the lender's approval. The borrower may require a short sale or another arrangement with the private lender if the sale price is less than the loan debt.
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