How to calculate rate with sellers terms?

Question

2 duplexes for 162k

Zillow estimates they are worth 84k and 85k each

They are both mostly brick, identical, and right next door to each other. All units 2br 1ba.

One roof has a leak, so it needs repair or possible replacement.

The street is probably C or D class in my opinion, mostly similar quality duplexes. There's some nice neighborhoods (300k+ houses) a block away, and some sketchier seeming neighborhoods a block away as well.

All 4 doors rent for $600 each, so $2400 a month. 2 tenants have been there for multiple years, 2 less than a year.

Seller wants 5k down each, and $550 a month each. So $1100 per month, with $100 going towards the principal, for 5 years, then a balloon payment.

Taxes for the 2 combined would be about $275 per month, and I'm guessing worst case $200 for insurance.

So 2400 income and 1575 in expenses, and lets say $300 per month for repairs and other unexpected things would leave me with an estimated cashflow of $525.

How do I figure out the actual interest rate I'd be paying the seller? Does this seem like a reasonable deal? I believe the seller has his own financing on the properties, so how would I protect myself from him not making his payments, keeping all my payments and getting foreclosed on?

The 10k down with no banks is really nice, but after 5 years i'd have payed him 66k in payments, plus the 10k down, and only 16k of that would go towards the actual 162k principal. I'm too new to know if that is normal or not.

Bryan Reid · Answer

Agreed that 20% equity by maturity time is a good goal.  If you're putting down $5K and only paying off $6K in principal, you'd likely need to fork up an addition $5200 to refinance (assuming a flat market).

But it still sounds like a it could be a good buy.

An $81K duplex bringing $1200 per month is very good.  I'd jump on that deal, even without optimal financing terms.  My goal would probably be to refi as soon as you had saved up the remainder of the 20% though.

One word of caution: don't trust Zillow as your only source for establishing the value of these two.  You don't want to be in the position of needing to refinance in 5 years, only to discover they only appraise for $70K...

Brent Coombs · Answer

I suspect that if you were to go to SOLD comps, you'd find some duplexes that sold for around the $70k mark, or even less? If so, my main concern would be your EXIT strategy.

ie. There'll likely be NO appreciation in the next 5 years there, but yet - a sure balloon!

Note: The Seller already believes that they'll be better off by sucking someone in who can't afford a bigger deposit, than they would be by either listing conventionally, or even keeping them! My 2c...

Bryan Reid · Answer

No problem although just wanted to clarify this is not an exact formula (depending on compounding) and it really doesn't apply well in this case.

Here, it sounds as though there is no true amortization.  Usually the ratio of principal to interest portion increases over time but it's sounding like in this case that isn't happening.

This will actually mean that the rate is gradually increasing each month (since principal balance is dropping but interest paid remains the same.)

You could put it in in a spreadsheet to figure out the rate each month.

By the fifth year you're paying around 12%.

It really might make your life easier if you could convince the seller to agree to a more conventional financing deal.  (Where you specify a rate, term and compounding type.)

Bryan Reid · Answer

Depending on compounding type, you can estimate interest rate by dividing the total interest paid during the first year by the loan amount.

So, if you're borrowing $152K ($162K-10K down), and paying $12K in interest (12 months x ($1100 - $100)) then:

interest rate = $12K / $152K = 7.9%

Obviously you could get a better rate at a bank, but there may be some advantages of seller financing that would make the higher rate worth it depending on your circumstances.

Alec Anderson · Answer

I agree the terms aren't amazing, but now that I understand them a little better I can negotiate more confidently.

I was also worried about the selling price more than the payments, since I should be able to cash flow. I'd really want 20% equity by the 5th year if I went to a bank to refinance. I'm thinking 140k or less should a safer deal.

Alec Anderson · Answer

Thanks for the formula Brian! I think the main advantage is that I wouldn't have to put the normal 20% down and could potentially put the difference, which is over 20k, into another deal. I'm still not sure how good of a deal it is, but at least I understand it more!

Kevin Manz · Answer

Are you sure $100/month isnt going towards interest instead of principal. If your right and it is going towards principal, its a terrible deal.

Bryan Reid · Answer

Confused here - you say $100 per month to principal, which after 5 years is $6000.  But then you say at the end of 5 years $16K in principal paid off.

Was this a typo?

How to calculate rate with sellers terms?

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