Borrowers who don't qualify for traditional financing may find that it's a better deal to get a mortgage directly from the owner. In an owner-financing arrangement, the seller agrees to lend the borrower some or all of the funds needed to purchase the house. The borrower then makes regular mortgage payments to the buyer that are comprised of interest and principal repayment.
A borrower can obtain owner financing to supplement a loan from a traditional bank, which is referred to as seller carryback. However, The Truth About Mortgage warns that many lenders won't agree to seller carryback financing.
Structuring the Mortgage
In order to calculate the payment for an owner-financed mortgage, you need the following information:
- Interest rate, or i. The interest rate should be determined by the borrower's down payment and credit history. A borrower who is putting down a sizable mortgage and has a good credit score can expect a lower interest rate. If you're making mortgage payments on a monthly basis, your interest rate is your annual interest rate divided by twelve. For example, if your annual rate is 12 percent, your monthly rate is one percent.
- The loan term. As with traditional mortgages, the term can vary based on the buyer and seller preferences. Terms of 5, 10, 15 and 30 years are common.
- The loan amount, or A. If the seller is financing 100 percent of the purchase, the loan amount is the home purchase price minus any down payment made to the seller. If it's seller carryback, it's whatever loan amount the buyer and seller have agreed upon.
- The number of mortgage payments you'll make, or n. If you're making mortgage payments on a monthly basis, this is your loan term in years multiplied by twelve. For example, if you have a 30 year mortgage and you pay every month., you'll make 360 total payments.
Calculating Mortgage Payments
The formula for a monthly mortgage payment is:
Payment = A*[i(1+i)n]/[1+i)n-1]
To calculate the payment, follow these steps:
- Add one to your monthly interest rate and raise it to the power of the number of payments you'll make. In our example, the interest rate is one percent and the number of payments is 360. To complete this step, we would add one to 0.01 -- for a total of 1.01 --- and raise it to the 360th power for a total of 36.
- Multiply the total from step one by the interest rate. In our example, that would be 36 multiplied by 0.01, or 0.36.
- Identify the total from step one and subtract one. For us, that would be 36 minus one for a total of 35.
- Divide the total from step three by the total from step two. For us, that would be 0.36 divided by 35, or 0.01.
- Multiply the total from step four by the loan amount to find the monthly payment amount. If the principle on the loan was $200,000, the monthly payment is 200,000 multiplied by 0.01, or $2,000.