Calculating the payment needed to cover just the interest on an owner-financed contract or promissory note is simple. Just follow three easy steps and avoid two common pitfalls.
Follow 3 Easy Steps To Calculate Interest Only
Step 1: Obtain the current principal balance and interest rate from the land contract or promissory note
Step 2: Times the balance by the interest rate
Step 3: Divide by 12
In fact it is so simple you don’t need the best financial calculator, any standard calculator will suffice.
Here are the steps in action:
Step 1: A seller-financed note has a balance of 100,000 at 8% interest
Step 2: $100,000 x 8% (or .08) = $8,000 (interest for the year)
Step 3: $8,000 divided by 12 = $666.67 (monthly interest only payment)
What It All Means
If the buyer pays just the interest every month then the balance stays the same and does not decrease.
If the buyer makes a payment that is more than the interest only portion then there is a principal reduction and the balance goes down.
Unfortunately there are three common mistakes people unknowingly make with interest only (I/O for short) payments.
3 Mistakes With Interest Only Balloon Notes When Owner Financing
Big Mistake #1 – No Balloon Mortgage Date
When a note calls for interest only payments the balance does not amortize. This means the repayment terms must state a date in the future when the full balance will be all due and payable.
When a note amortizes a portion of the payment goes to interest and a portion goes to principal. Each month the balance goes down and the note eventually pays off.
With an interest only payment there is no application to the principal. That means if the note fails to include the balloon date then it would never have to be paid off! Sellers and note buyers alike want to know that the buyer will eventually have to pay for the property they purchased.
Big Mistake #2 – No Equity Build
Since the payment is only covering the interest the buyer is not building equity through amortization. A buyer without equity or “skin” in a property purchase has a much higher likelihood of both delinquency and foreclosure.
This high risk factor can be offset when a buyer makes a large down payment at closing. On the flip side the risk is increased when a buyer makes a low or no down payment with an interest only repayment plan.
If values decline it can quickly lead to the buyer being underwater, owing more than the property is worth.
In the current market an amortizing payment is preferable to the majority of note investors.
Big Mistake #3 – Buyer Can’t Make The Balloon Payment
Eventually the balloon payment will come due. It’s important to ask, will the buyer realistically be able to make the balloon payment when it comes due?
To make the balloon payment they will likely need to obtain refinancing in the future. Will they be able to afford going from interest only payments to a potentially higher amortizing payment that includes principal and interest?
What about equity? It can also make it hard for the buyer to obtain refinancing when the balloon is due if they haven’t built any equity.
You want to set the buyer up for success when selling with financing.
Also consider whether the buyer is living in the property as their home or is purchasing as a rental for investment. The introduction of the Dodd Frank Act in 2014 put some additional requirements on sellers offering financing to owner occupants with balloons depending on the entity and number of times offering seller financing in a year. It is now more typical to see balloon notes on investor deals or hard money loans.
Are you a buyer looking to purchase property with seller financing?
A seller that wants to create notes with owner financing?
A finder that wants to earn money referring deals to note investors?
We have over 300 articles dedicated to answering your questions!
Additional Owner Financing and Note Investing Resources
Interested in learning more about real estate notes, how to calculate cash flows, and the benefits of investing in notes? Check out these additional resources from NoteInvestor.com
Loriana Fiorenzi says
We are thinking about selling our 10 unit downtown business property for 250,000. The property has a second floor that can be converted into apartments. We have a buyer interested who wants to buy it on contract. We have no mortgage or liens against the property. All taxes and insurance are up to date. We’re 65 and retired so I don’t want a long term contact. My husband thought 800.00 for 20 years which is 60k less than asking price with no interest plus term is long. Help!!
Tracy Z says
Hello Loriana, Thanks for stopping by our site while doing your homework. The beauty of offering seller financing is that you can negotiate the terms that work for you and the buyer. You also get the benefit of earning interest income like the banks do. I definitely suggest getting full market value and charging interest. This article goes into more detail: https://noteinvestor.com/create-notes-seller-financing/ If you ever want to sell and liquidate the note you will receive a much better price by charging interest and following the guidelines in that article. Tracy
Michael Ebarb says
My elderly mother owns 5 rental homes and she wants to owner finance 1 and use down payment to repair others. Also receiving monthly cashflow. She already has one property she sold with low down and she hasn’t kept up her oversight of terms verifying insurance,taxes,etc. Since she over spends Monthly (grandkids) selling outright is not gpod idea. Everyday she is contacted by investors wanting to buy her properties. She has one that agreed to her terms of 10 percent down and 4 percent interest. My concerns are down payment too low and why would investors be willing to pay interest. I worry if market downturns and buyer getting under water and walking away or possibility of swindlers. I am slowly taking on more property management duties and likely inherit the real estate. I fear I will have to foreclose and incur costly fees. Is there anywhere I can learn fast how to owner finance properly and prevent costly mistakes? I am in Dallas Texas and by the way we are cash poor. Thank you for any advice you can share.
Tracy Z says
Hello Michael, One of the things you can do to help minimize the risk of foreclosure is to get a higher down payment and also underwrite the buyer. We also suggest a higher interest rate when seller financing. It not only helps your return, it will also help minimize the discount should the note be sold later to a note buyer on the secondary market. We recently wrote an article and recorded a video with some of the best practices when creating notes with owner financing. You can find that on the website here: https://noteinvestor.com/create-notes-seller-financing/
NATALIA QUIROZ says
Hello, Im trying to buy a commercial property in Florida.
Owner is offering financing but the terms seem ridiculous to me:
12% interest fixed (interest only, no amortization)
Ballon 5 years
3 years penalty ( no refinance before 3 years)
loan origination 3 points
$499 processing fee
Can you please give me your opinion on this?
Tracy Z says
Hello Natalia, Generally commercial rates are higher than residential but the terms you outlined are on the higher side in general. We go over some common terms here: https://noteinvestor.com/create-notes-seller-financing/ There are times you might be willing to pay higher terms if the property has more than enough net cash flow to support the payments or there is some known upside. Or perhaps you negotiate a lower sales price but pay higher terms. If you can get bank financing on the commercial property at better terms that is also an option. It is possible the seller would be willing to negotiate various terms (rate, term, origination points).
Jeremey Carpenter says
I’m in discussions with my landlord about purchasing the home. They are proposing 90k. What would a monthly payment look like for a 15 or 30 year.
What would happen if they passed away before the balance is paid (they are elderly)?
Josephine Cruz says
I am buying a home and the owner is financing, it’s selling for 80000 and I’m giving 10000 down what are the tax rates , or can the owner charge any tax rate they want
Tracy Z says
Congrats on your pending home purchase with seller financing. There are real estate taxes charged by the county (and also the city in many places). To find out the current annual real estate taxes you can contact the county tax assessor. You will want to also ask if there are any past due real estate taxes, special assessments/liens, or exemptions. If you use a title company and closing agent they usually check this and prorate at closing. The seller does not set the real estate tax rate however they might ask that you pay 1/12th the amount each month to set aside in an escrow/reserve account to pay the real estate taxes when they come due.
For the terms of repayment (like the interest rate charged on the note) the seller can request what they want, provided the rate does not violate any usury laws. Ultimately those items can be negotiated between the two of you as part of the purchase offer and then incorporated into the Note and Mortgage (or Note and Trust Deed).
Be sure to use an attorney, title company, and/or closing agent for the purchase. The seller may also use a servicing agent to collect and track the monthly payments after closing.
Will Kaeble says
I am thinking about buying the rental property I live in. I want to make sure all my ducks are lined up when I propose this to my landlord. We have discussed this in the past and she seemed open about it as she would like to have a monthly stream of cash. I would appreciate any information you may have that will help. I will be happy to cover your costs for this information if it helps.
Tracy Z says
Hello Will, Here is a helpful article:
Feel free to contact me with any questions. You will definitely want to work with a title company and local attorney/escrow agent for the closing and doc prep.