Owner Finance Deal. Good or Bad?

[Patrick Goswitz]

I was thinking about owner financing a property to a buyer and I need some help please to figure out if this is a good deal or not.
I paid $235,000 for the home. Here would be the terms with the buyer:

Sales Price: $315,000 (NOT worth this. Probably worth about 260k)
Down payment: $100,000
Interest rate: 6.75% (option to raise rate in 3 years but not down)
Loan Term: 30 years
Buyers monthly payments:  $1,394.49

When I crunch this into Chat GPT is says I am getting a 271.87% ROI. Which over 30 years is about 9% (at least I thought)
It then gives me an annualized ROI CAGR of only 3.1%??? Which sounds horrible. 

Please let me know your honest thoughts!!!

[Jeremy Fleming]

Ok, so don't mind me - I dropped your whole write up into Chat, and this is what it came back with for me:
Let’s dive into the numbers together and see what we can work out about this owner financing deal you’re considering.

First off, the idea of selling the house at $315,000 when its market value is around $260,000 definitely swings in your favor financially. That high down payment of $100,000 also helps reduce the risk quite a bit since it gives you a good chunk of cash right away and reduces the loan amount your buyer needs.

To get a clearer picture of your return on investment (ROI) and your annualized ROI (CAGR), let's break it down step-by-step.

### Initial Calculations
- **Initial investment:** You bought the house for $235,000.
- **Sales price:** $315,000.
- **Down payment received:** $100,000.

### Loan Details (After Down Payment)
- **Amount financed:** Sales price - down payment = $315,000 - $100,000 = $215,000.
- **Monthly payment from buyer:** $1,394.49.
- **Loan term:** 30 years (360 months).

### Calculating Total Returns
- **Total payments received over 30 years:** $1,394.49 x 360 = $501,816.40.
- **Total amount received (including down payment):** $501,816.40 + $100,000 = $601,816.40.

### Calculating ROI
- **Total profit (not accounting for costs like maintenance, taxes, etc.):** Total amount received - initial investment = $601,816.40 - $235,000 = $366,816.40.
- **ROI over 30 years:** ($366,816.40 / $235,000) x 100 = 156.09%.

### Calculating Annualized ROI (CAGR)
The formula for CAGR (Compound Annual Growth Rate) is:
\[ CAGR = \left(\frac{Final\ Value}{Initial\ Value}\right)^{\frac{1}{Number\ of\ Years}} - 1 \]
In your case:
\[ CAGR = \left(\frac{\$601,816.40}{\$235,000}\right)^{\frac{1}{30}} - 1 \]

Let's calculate this:

\[ CAGR = \left(\frac{601816.40}{235000}\right)^{\frac{1}{30}} - 1 \]
\[ CAGR = (2.56)^{\frac{1}{30}} - 1 \]
\[ CAGR \approx 1.0303 - 1 \]
\[ CAGR \approx 0.0303 \text{ or } 3.03\% \]

This means your annualized return is about 3.03% each year over 30 years. While this might sound low compared to some high-yield investments, it's steady and relatively safe given the high down payment and the over-market selling price.

In conclusion, while the 3.03% CAGR might seem small, remember that this calculation doesn’t consider other potential financial benefits like tax advantages or the value of having the capital upfront. Plus, it’s fairly risk-free post-down payment, which is a significant benefit. It’s really about weighing these returns against other potential investments you could make with the capital if you didn’t lock it into this property.

Hope that helps clarify things! Let me know if there's anything else you want to figure out.

NOW, I then asked Chat how the numbers looked if we include a 5 year balloon:

Switching to a 5-year balloon payment structure changes the dynamics of your deal quite a bit. With this setup, the buyer would still make the same monthly payments, but instead of stretching those payments over 30 years, they would need to pay off the remaining balance at the end of 5 years. Here's how that would look:

### Details with a 5-Year Balloon Payment
- **Sales Price:** $315,000.
- **Down Payment:** $100,000.
- **Amount Financed:** $315,000 - $100,000 = $215,000.
- **Interest Rate:** 6.75%.
- **Monthly Payment:** $1,394.49.

### Loan Balance at the End of 5 Years
- **Number of Payments:** 5 years x 12 months = 60 payments.
- **Total Payments Made by Buyer in 5 Years:** $1,394.49 x 60 = $83,669.40.

We need to calculate the remaining balance after 5 years of payments. The remaining balance is the initial loan amount ($215,000) compounded monthly at the interest rate, minus the total payments made. This can be calculated using the formula for the balance of an amortizing loan. Let's calculate that.

### Calculate Remaining Loan Balance
The formula for the remaining balance \( B \) of a loan after \( n \) payments is given by:
\[ B = P \left(1 + r\right)^n - \frac{X \left(\left(1 + r\right)^n - 1\right)}{r} \]
where:
- \( P \) is the principal loan amount ($215,000),
- \( r \) is the monthly interest rate (6.75% per annum / 12 months = 0.5625% per month),
- \( X \) is the monthly payment amount ($1,394.49),
- \( n \) is the number of payments made (60).

Let's calculate the remaining balance after 60 payments.

```python
P = 215000 # Principal loan amount
r = 0.0675 / 12 # Monthly interest rate
n = 60 # Number of payments
X = 1394.49 # Monthly payment

# Calculate remaining balance
B = P * (1 + r)**n - X * ((1 + r)**n - 1) / r
B
```
This calculation will give us the balloon payment amount the buyer would need to pay at the end of 5 years to completely own the home. Afterward, we'll discuss how this impacts your return on investment. Let's calculate this.

After 5 years of monthly payments, the remaining balance on the loan would be approximately $201,832.48. This is the balloon payment that the buyer would need to pay to fully own the home.

### Financial Impact of a 5-Year Balloon Payment
Now, let's summarize your financials with this balloon payment setup:
- **Total received from monthly payments over 5 years:** $83,669.40.
- **Balloon payment after 5 years:** $201,832.48.
- **Initial down payment:** $100,000.
- **Total amount received:** $83,669.40 + $201,832.48 + $100,000 = $385,501.88.

### Return on Investment (ROI)
- **Total profit:** Total amount received - initial investment = $385,501.88 - $235,000 = $150,501.88.
- **ROI over 5 years:** ($150,501.88 / $235,000) x 100 = 64.04%.

### Annualized ROI (CAGR)
To calculate the Compound Annual Growth Rate (CAGR) for the 5-year period:
\[ CAGR = \left(\frac{Final\ Value}{Initial\ Value}\right)^{\frac{1}{Number\ of\ Years}} - 1 \]
\[ CAGR = \left(\frac{385501.88}{235000}\right)^{\frac{1}{5}} - 1 \]

Let's calculate this CAGR:

\[ CAGR = \left(\frac{385501.88}{235000}\right)^{0.2} - 1 \]
\[ CAGR \approx 1.1054 - 1 \]
\[ CAGR \approx 0.1054 \text{ or } 10.54\% \]

This 10.54% annualized return is substantially higher than the 3.03% from the 30-year term scenario. This higher return reflects the increased risk and responsibility on the buyer to secure a large sum for the balloon payment or refinance the loan within 5 years.

If this seems like a more attractive option to you, considering your financial goals and risk tolerance, it might be a great way to go! Let me know if you need more details on any part of this calculation or other aspects of your deal!