Real Estate and Creative Financing Glossary
7 min read · Updated
The short answer
This glossary defines the terms used in owner-financed and creative real estate transactions. The most consequential distinctions for a buyer are between a promissory note and a security instrument, between a mortgage and a contract for deed, and between amortization and term - because each pair is routinely confused and each confusion is expensive.
Key takeaways
- A promissory note is the promise to pay. A mortgage or deed of trust is what secures it against the property. You sign both.
- Amortization sets the payment; the term sets when the balance is due. They are frequently different numbers.
- A contract for deed is not a mortgage. The seller keeps title until you finish paying.
- A due-on-sale clause is the central legal risk in subject-to and wraparound transactions.
- Loan-to-value governs refinancing, and it is measured against appraised value rather than your purchase price.
Owner financing and note terms
- Owner financing
- A sale in which the seller extends credit to the buyer instead of the buyer obtaining a bank loan. The buyer signs a promissory note and pays the seller directly. Also called seller financing.
- Promissory note
- The document in which the borrower promises to repay a stated amount, at a stated interest rate, on a stated schedule. It creates the debt but does not by itself give the lender any claim on the property.
- Deed of trust
- A security instrument used in many states in place of a mortgage. It involves three parties - borrower, lender and a neutral trustee who holds title in trust and can conduct a non-judicial foreclosure if the borrower defaults.
- Mortgage
- A security instrument giving the lender a lien on real property as collateral for a debt. Used loosely to mean the loan itself, but strictly it is the document that secures the promissory note.
- Amortization
- The schedule over which a loan balance is repaid through regular payments of principal and interest. A longer amortization produces a lower monthly payment and slower principal reduction.
- Term
- The period until the loan balance becomes due. In owner financing the term is frequently shorter than the amortization, which is what creates a balloon payment.
- Balloon payment
- A lump sum equal to the entire remaining loan balance, due on a fixed date. Common in owner-financed notes, where a payment calculated on a 30-year schedule may come due in full after 3 to 7 years.
- Prepayment penalty
- A fee charged for repaying a loan early. Its presence matters in owner financing because the usual exit is an early refinance, which a penalty makes more expensive.
- Seller carryback
- Financing in which the seller carries a portion of the purchase price as a second lien behind a new first mortgage from a conventional lender. The first lender must be told and must permit it.
- Loan servicing
- Administration of a loan - collecting payments, applying them to principal and interest, and keeping records. In owner financing a licensed third-party servicer is often used so both parties have independent documentation.
Creative financing structures
- Subject-to
- A purchase in which the buyer takes title but the seller’s existing mortgage remains in place and unpaid. The buyer makes the payments while the loan stays in the seller’s name. Generally triggers the loan’s due-on-sale clause.
- Wraparound mortgage
- A new note from seller to buyer that encompasses, or wraps, an existing underlying loan the seller keeps paying. The buyer pays the seller, and the seller is responsible for paying the underlying lender.
- Due-on-sale clause
- A mortgage provision permitting the lender to demand immediate repayment of the full balance if the property is sold or transferred. Present in nearly all US mortgages and the principal legal risk in subject-to and wraparound deals.
- Contract for deed
- An installment sale in which the buyer takes possession and makes payments while the seller retains legal title until the balance is paid in full. Also called a land contract. In some states the seller may recover the property through forfeiture on default, a faster process than foreclosure.
- Lease option
- A lease combined with a contractual right, but not an obligation, to purchase at a set price within a set period. The occupant is a tenant until the option is exercised and a sale closes.
- Option fee
- A payment made to acquire a purchase option under a lease option. It is typically non-refundable and is forfeited if the buyer does not exercise the option.
- Assignment
- Transfer of a contract or a note to another party. A note that may be assigned can be sold by the seller to a third party, who then becomes the party you owe.
Valuation and investment metrics
- After-repair value (ARV)
- The estimated market value of a property once renovation is complete, derived from closed sales of comparable finished properties in the same submarket.
- Net operating income (NOI)
- A property’s income after operating expenses but before debt service, capital expenditure, depreciation and income tax. The basis for income-approach valuation of commercial property.
- Capitalization rate
- Net operating income divided by property value, expressed as a percentage. A market-determined pricing measure - a lower cap rate means a higher price relative to income.
- Debt service coverage ratio (DSCR)
- Net operating income divided by annual debt service. Measures how comfortably a property’s income covers its loan payments. Commercial lenders commonly require 1.20x to 1.25x.
- Loan-to-value (LTV)
- The loan amount as a percentage of the property’s appraised value. It governs how much a lender will advance, and is measured against appraised value rather than the price you paid.
- Cash-on-cash return
- Annual pre-tax cash flow divided by the cash actually invested. Measures the return on your own money rather than on the property’s full value.
- Capital expenditure (CapEx)
- Spending on major components with a long life - roof, HVAC, water heater, sewer line. Budgeted separately from routine repairs because it is lumpy and predictable over time.
- Zestimate
- Zillow’s automated valuation estimate. Useful as an initial reference point, but it is a model output rather than an appraisal and is less reliable for unusual properties and vacant land.
Closing, title and process
- Title search
- An examination of public records to establish who legally owns a property and what liens, judgments or claims are recorded against it.
- Title insurance
- A policy protecting against loss from defects in title that existed before the policy was issued - undisclosed liens, forged documents, or errors in the public record.
- Lien
- A legal claim against a property securing a debt. Liens generally must be satisfied before clear title can transfer, and unreleased liens are a common obstacle in older inventory.
- Escrow
- Funds or documents held by a neutral third party until agreed conditions are met. Also refers to the account a servicer uses to collect and pay property taxes and insurance.
- Foreclosure
- The legal process by which a lender enforces its security interest and recovers property after a borrower defaults. Procedure and timeline vary substantially by state.
- Forfeiture
- Termination of a buyer’s rights under a contract for deed following default. In some states it is faster and cheaper for the seller than foreclosure, and the buyer may lose amounts already paid.
- Ability-to-repay
- A requirement, introduced by the Dodd-Frank Act, that a creditor make a reasonable determination that a borrower can repay a residential mortgage loan. It applies to some seller-financed transactions.
- SAFE Act
- Federal legislation setting licensing and registration standards for residential mortgage loan originators. Relevant to owner financing because it limits how frequently an individual may originate seller-financed residential loans.
Frequently asked questions
- What is the difference between a promissory note and a mortgage?
- The promissory note is the borrower’s promise to repay a stated amount on stated terms - it creates the debt. The mortgage, or deed of trust, is the separate document that secures that debt against the property and gives the lender the right to foreclose. A financed purchase involves signing both.
- What is the difference between amortization and loan term?
- Amortization is the schedule used to calculate the payment - commonly 20 or 30 years. The term is how long before the remaining balance is due. In owner financing they are frequently different: a payment calculated over 30 years with a 5-year term produces a low monthly payment and a large balloon at year five.
- What is a contract for deed?
- A contract for deed, also called a land contract, is an installment sale in which the buyer takes possession and makes payments while the seller keeps legal title until the balance is fully paid. It differs from owner financing with a mortgage, where the buyer takes title at closing, and in some states it offers the buyer weaker protection on default.
- What does subject-to mean in real estate?
- A subject-to purchase is one where the buyer takes title to a property subject to an existing mortgage that is not paid off at closing. The buyer makes the payments but the loan remains in the seller’s name. It generally triggers the mortgage’s due-on-sale clause, which lets the lender demand full repayment.
- What does LTV mean and why does it matter?
- Loan-to-value is the loan amount expressed as a percentage of the property’s appraised value. It matters most at refinance: a lender will size the new loan against the appraisal, so if the property appraises lower than expected, the available loan may not cover an outstanding balloon balance.
