An owner-financed sale priced the way a note buyer will price it: the rate that lets the seller cash out at face, and what each point below it costs.
Charge the rate at which a note buyer would pay what you want for the note, because that is what the note is worth the day you sign it. On an illustrative $220,000 house sold with 10 per cent down, a $198,000 note amortising over 30 years with a five-year balloon sells at face only at a 10.37 per cent rate to a buyer who wants 10 per cent net. At 8 per cent it fetches 90.90 per cent, $18,023.76 less.
Worked in full in The Mortgage Note Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A seller who carries back a note has two assets: the down payment and a stream of payments. The stream is worth its rate only to someone who holds it to the end and is happy with that rate. Most sellers either need the cash later or want the option to sell, and the market for performing notes prices them at the buyer's yield, net of servicing and costs, not at the note rate. The rate negotiated at the kitchen table is therefore a price negotiation in disguise: every point below the note buyer's yield is a discount the seller will take if they ever sell.
| Input | Value |
|---|---|
| Sale price of the house | 220,000 |
| Down payment, 10% | 22,000 |
| Note, 90% of the price | 198,000 |
| Amortisation / balloon | 360 months / month 60 |
| Note buyer's required yield, net | 10% |
| Servicing a month | 30 |
| Buyer's acquisition and boarding costs | 1,400 |
The yield is an annual rate compounded monthly, the convention for notes, and is illustrative: real buyers ask more for thinner equity, unseasoned payments and weaker borrowers.
The note buyer's price is the present value of what it will receive, each payment net of servicing plus the balloon, at its required yield, less its costs. Worked at an 8 per cent note rate:
Payment = PMT(8%/12, 360, 198,000) = 1,452.85
Balloon after payment 60 = 188,238.32
PV of 60 net payments of 1,422.85 at 10%/12 = 66,967.14
PV of the balloon = 188,238.32 / (1 + 10%/12)60 = 114,409.10
Price = 66,967.14 + 114,409.10 − 1,400 = 179,976.24, 90.90% of the note
Excel: =PV(10%/12, 60, -(PMT(8%/12, 360, -198000)-30), -FV(8%/12, 60, PMT(8%/12, 360, -198000), -198000))-1400
To find the rate that gives par, solve the same formula for the note rate with Goal Seek or a bisection: the price equals 198,000 at 10.37 per cent, a payment of 1,791.51. The rate sits above the buyer's 10 per cent because the servicing and the 1,400 of costs come out of the buyer's pocket and the rate has to pay for them. For a price of 95 per cent the rate is 9.07 per cent; for 90 per cent, 7.76 per cent.
| Note rate | 5-year balloon | 10-year balloon | Fully amortising |
|---|---|---|---|
| 6% | 83.36% (32,957) | 74.43% (50,630) | 65.89% (67,546) |
| 7% | 87.10% (25,533) | 80.19% (39,223) | 73.38% (52,711) |
| 8% | 90.90% (18,024) | 86.08% (27,567) | 81.18% (37,265) |
| 9% | 94.72% (10,445) | 92.07% (15,703) | 89.25% (21,277) |
| 10% | 98.58% (2,812) | 98.15% (3,670) | 97.57% (4,819) |
| 11% | 102.46% | 104.29% | 106.08% |
The term matters as much as the rate. With a five-year balloon, one point of rate, from 7 to 8 per cent, is worth 3.79 points of price, 7,509 on this note. Fully amortising, the same point is worth 7.80 points, 15,447, because the buyer's discount runs for 30 years instead of five. A seller who must offer a low rate to close the sale should keep the balloon short; a seller who wants a long note should not go below the buyer's yield. The par rate itself barely moves with the term: 10.30 per cent with a ten-year balloon, 10.29 per cent fully amortising.
Seen as cash: sell the house at 220,000 with an 8 per cent note and sell the note at once, and the seller receives 201,976, 91.8 per cent of the headline price. At 6 per cent, 187,043, 85.0 per cent. At 10.37 per cent the headline is the cash.
Sellers often hold out for full price and give away the rate, or the reverse, without noticing that the two are the same number. A 220,000 sale at 6 per cent with a fully amortising note is worth 152,454 in cash; a 190,000 sale at 10.37 per cent with the five-year balloon is worth 189,617. The second mistake runs the other way: pushing the rate to par without checking the payment. At 10.37 per cent the borrower pays 1,791.51 a month against 1,452.85 at 8 per cent, and a note buyer prices the extra default risk of a stretched borrower, which can take back part of what the rate added. How much is worked in how to price default risk into a performing note.
Seller financing of a home is regulated: lending rules, licensing and usury limits vary by state, and the tax rules impute a minimum interest rate. Check them before setting any rate. Nothing here is legal, tax or investment advice.
The book prices a performing owner-financed note with a balloon from the buyer's side, and the free workbook for this case gives the price at any required yield, so the same table can be run for your own terms. The buyer's side of the same arithmetic is in how to price a mortgage note for a target yield.
There is no single market rate; the useful question is what a note buyer would pay for the note at a given rate. On the illustrative $198,000 note with a five-year balloon, a buyer requiring 10% net pays 90.90% of face at 8%, 94.72% at 9% and par at 10.37%. A seller who will hold to maturity simply earns the note rate.
Yes, at any rate below the buyer's yield, because the buyer's discount applies for five years instead of thirty. At 8% the illustrative note sells for 90.90% of face with a five-year balloon, 86.08% with a ten-year one and 81.18% fully amortising. One point of rate is worth 3.79 points of price with the balloon and 7.80 without.
Not without checking affordability. On the illustrative note the payment is $1,452.85 at 8% and $1,791.51 at 10.37%. A borrower stretched by the higher payment is more likely to default, and a note buyer prices that risk, so part of the extra rate can come back as a lower price.
This article is one calculation from The Mortgage Note Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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