As far as structure, that is both the advantage and disadvantage of owner financing. The buyer needs to have the right to do what they plan with the property. You need some restrictions that prevent an auto junk yard or hog farm. It needs to be clear who pays taxes and that either party has the right to pay them (and get reimbursed) if the other doesn’t. Within some range the IRS deems “reasonable” you can choose an interest rate and purchase price that yields the best division of capital gain and interest income. Payment amounts, frequency, and interest don’t have to stay the same for the life of the note. Notes can sometimes be structured to avoid problems with heirs.

If it is an interest only loan there is no amortization. Your payment would be the monthly interest on the outstanding balance at whatever rate it had adjusted to.

In the current economic times many people are worried about inflation. Many are also having a difficult time finding “safe” investments with decent returns. From your description you are a solid buyer and I presume the seller is comfortable with you. That being the case, the proposed terms let him lock in a return that is probably higher than he might get elsewhere and which will adjust for inflation. Your loan might very well be one of his highest yielding investments so keeping as much invested as he can (no principle reduction) would make sense.

Our thought process was to get owner financing for now, and then refinance with the bank if and when the tenant renews its lease. We are putting over 60% in equity, so we have sufficient cash flow and cash reserves to handle an unforeseen problem. That being said, I have never used owner financing and was a little unsure about the tentative terms. In order to figure out our payments, would I just use 3 years as the length of amortization (instead of 15 with the bank)? If this is correct, then it seems as though our payments would be lower with the owner financing. Also, why would the seller offer an interest only loan and not have us pay principal as well? Thank you again for your help.

What do you expect to happen over the next three years which will make paying the balloon or refinancing with terms which make sense to you possible?

With a bank loan I think you are vulnerable to more issues which are outside your control. For example, even if you are making your payments on time and your numbers are good the bank may decide to leave the area, etc.

Have you considered a lease/option with the seller. That would give you the right to perform but not the requirement.

I think the interest rate and/or payment amounts on the two alternatives you describe are the least important factors in your decision.

Good luck with it.

Thank You!

Interest rate frequently makes a good negotiating point because it may have a lot more importance to one party than the other. Thus, the party that doesn’t care can make a “concession” which has value to the other side but costs them little or nothing.

What do you earn on other investments? Since there is no property to damage, this should be a low risk loan. That would mean you could set the rate low and still double your return on investment. On the other hand I believe bank loans to buy property like this are VERY hard to find, have high fees, and a lot of paperwork and other requirements. My daughter actually had to have property re-platted when they paid off the owner financing on a property with bank financing. That would suggest you could ask for a high rate and still be cheaper than the buyers other choices.

Interest is taxed as current interest income. Profit from the sale is taxed at capital gains rates. You can play with the amount of each you receive by raising the price and lowering the interest or lowering the price and raising the interest rate. The payment can stay the same; it just changes how the money is allocated.

It all comes down to what you and the buyers agree is “fair”.