Yes, that is how it works.
I've bought plenty of houses on contract that I later refinanced out of. It used to be that you'd recommend a minimum of 5 years on the balloon payment so that the contract purchaser had time to build up around 20% equity. That allowed the purchaser to then refinancing out of the contract without having to pay PMI.
Just a technical consideration- different lenders handle paying off a contract differently. I found that the local lenders considered me paying off a contract with a refinance to be a no-cash-out type of transaction because refi's weren't allowing any cash out at that time. I wanted to pull money out of my house (was an investment) so I wrote up a sales contract with the contract seller at a sales price that represented its market value. The lender then treated that as a sale, and as such, I was able to pull equity out upon closing. The contract seller got paid their balance and I was able to get a check for the equity at closing.
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