Question: We have had our house on the market for over one moth, with absolutely no nibbles. We lowered the sales price, but to no avail. A friend suggested that we consider taking back financing, but do not know if this legal or how it works. Is this something we should consider?

Answer: You are asking about an installment sale, and yes, it is legal. There are risks, but if structured properly, it may be the carrot to convince potential purchasers to go to settlement on your house.

Here's how it works. Let us assume that you either have no mortgage on your home or that it is relatively low. Your house should sell for $450,000. You enter into a contract with potential purchasers whereby they give you 10 percent down ($45,000) and you take back the balance -- $405,000 -- by way of a first deed of trust (mortgage).

If you have a current mortgage on your property, in order to take back a first deed of trust, you will have to pay off that existing mortgage. Otherwise, this arrangement can only be a second deed of trust, and that raises other legal questions which are not the subject of today's column.

Your buyer goes to settlement. The title attorney receives the $45,000 deposit, which is used to pay off your outstanding mortgage. The buyer signs a promissory note, which is secured by a first deed of trust. You will have to reach agreement with your buyer on the terms and conditions of the note: When will it become due? What interest rate will be charged? Will this be a fixed rate loan or an adjustable?

Your attorney should prepare these documents, rather than rely on the title attorney. There are many legal protections which should be included in those loan documents, such as:

• penalty fees for late payments;

• loan becomes due when the property is sold or transferred; this is known as a "due on sale" clause;

• attorneys fees to be awarded to the prevailing party should litigation be required; and

• the borrower must provide you with proof that the real estate taxes and insurance have been paid on a timely basis, and must add you as a "beneficiary" on the home owners insurance policy.

Let us further assume that the buyer agrees to pay the $405,000 in monthly installments of interest only at 5.5 percent. The loan will come due -- i.e. balloon -- in 7 years. The monthly payments will be $1,856.25. Keep in mind that because this is an interest only loan, the borrower (your buyer) will at all times still owe the full amount of the principal which is loaned.

At the end of each year, you will have to advise your buyer -- and the IRS -- as to the amount of interest which you received during that calendar year. Since the loan is secured by a deed of trust which must be recorded among the land records where the property is located, your buyers have the right to claim these interest payments as a deduction on their income tax return.

The money which you receive is ordinary income which you must also report when you file your 1040 income tax return.

But let's change the terms so that a portion of the monthly payment reduces the principal, as well as pays the monthly interest. Each installment payment generally will consist of three things: interest income, a return of the seller's adjusted basis in the property (in other words, what the seller paid the for property) and profit (gain) on the sale. As discussed above, the interest income portion is taxed as ordinary income at the seller's income tax rate. The return on basis has no taxable consequences. However, the profit must be reported as capital gain. There is a formula whereby the gain is prorated over the years in which such payments are received. Ask your financial advisor to run the numbers before you decide to go the installment sale route.

An installment sale is not risk free. If your buyer cannot make the monthly payments, you may have to foreclose on the property. And if your borrower files for bankruptcy relief, you may have to wait some time before you can foreclose, even though you are a secured creditor which means that you have certain priorities in the bankruptcy court.

But there are positive aspects to such a sale. It may be the key to getting a quick sale. Your buyer can get a lower interest rate than is currently available in the open mortgage market, and will not have to pay all of the lender's fees and charges. Additionally, you may be able to get a better interest rate from your buyer than you would get if you just put the entire sales proceeds into a safe, secured investment.

An installment sale is one tool in the creative financing which should be in the arsenal of all home sellers -- especially in slow markets.