Interest

In depth

Interest compensates the lender for the time value of money and the risk of nonpayment. In seller financing, interest rates are typically 1 to 4 percentage points above prevailing bank rates because seller-financed buyers cannot qualify conventionally. Misconception: interest is not capped at usury limits in every transaction; many states exempt purchase money loans, but not all do. Practically, the IRS requires that any seller-financed deal carry a stated interest rate at least equal to the AFR. If the rate is below AFR, the IRS imputes interest, increasing the seller's taxable income. Sellers should structure interest to reflect risk, while buyers should compare effective rates against alternatives. Annual 1098 statements help both parties report correctly.