It was a typical phone call, “I understand you purchase land contracts notes?” I replied, “Absolutely! What can you tell me about the terms of the note?” The response I got was one I was well prepared for, and you should be too. “Well, the note is for 10 years, with a $25,000 balance, payments are $403.34 a month”. I didn’t have to ask what the interest rate is because I know how to calculate it….. 15%. Learning how to calculate missing information can give you a leg up on everyone else when it comes to buying notes. I created an easy to use Excel spreadsheet here that you can use to calculate missing values of a note.
Using the Excel spreadsheet or not, remember the four components that are key to determining what the note is worth. These four components are also your starting point for determining how much you can pay for the note.
Number of Payments (N): Tells you how many payments in the note you can expect to receive based on the other variables provided. If expressed in years, you must multiply by 12.
Interest Rate (I): Gives the effective interest rate on the note. One thing to remember when calculating interest rates, always divide the interest rate by 12. (For each month of the year)
Payment (PMT): Identifies the current monthly payment you can expect to receive of principle and interest over the life of the note.
Present Value (PV): The present value of the note based on a series of future payments.
Once you know these four components, you can start analysis to determine how much you can afford to pay when purchasing the note. You can also determine what your rate of return will be. Next week, we will use this framework to calculate how much we can pay for the note based on the four components and our own expected rate of return.
Photo Credit: Horia Varlan