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Understanding Payment Structures

When you take out a land loan or refinance one, you know that you are required to make regular payments over the life of the loan. What you may not understand are the factors that go into determining that payment and how they impact your cost of ownership and cash flow. Let's take a look:

Key Factors of a Payment

The amount of your payment is determined by four primary factors:

  • Amount borrowed
  • Interest rate
  • Term of the loan (number of years)
  • Frequency of payment

For example, if you borrow $100,000 at a 5% interest rate over 20 years on an annual payment schedule, your payment will be approximately $8,100 per year. Keep these numbers in mind as you continue to read.


Even Payments

Each time you make a land loan payment, a portion of the payment goes toward the principal (the amount of money you borrowed) and the interest (the amount owed to the lender for using their money). If our borrower elects to have an even (or level) payment, they will pay $8,100 each year for 20 years.

On an even payment schedule, a larger portion of your payment goes toward interest at the beginning of the land loan term, as you can see in the sample amortization schedule below.

#PaymentInterestPrincipalBalance
1$8,102.11$5,4444.44$2,657.67$97,342.33
2$8,102.11$4,934.72$3,167.39$94,174.94
3$8,102.11$4,774.15$3,327.96$90,846.98
4$8,102.11$4,605.44$3,496.67$87,350.31


As your loan reaches maturity, these amounts flip and more of your payment is allocated to paying down principal.

#PaymentInterestPrincipalBalance
17$8,102.11$1,457.88$6,644.23$22,035.32
18$8,102.11$1,117.07$6,985.04$15,050.28
19$8,102.11$762.97$7,339.14$7,711.14
20$8,102.11$390.97$7,711.14$0.00


With this structure, the cost of ownership (the amount you pay to borrow $100,000) comes out to be approximately $162,020.

Decreasing Payments

Did you know you might also have the option to use a decreasing payment schedule? Under this structure, the borrower pays down a set amount of their principal each year while the interest payments shrink over the life of the loan. This structure requires higher payments up front, but significantly smaller payments toward the end of the loan.

As detailed below, you can see that the principal payment is $5,000 throughout the life of the loan, while the interest payment continuously gets smaller.

#PaymentInterestPrincipalBalance
1$10,4444.44$5,444.44$5,000.00$95,000.00
2$9,815.97$4,815.97$5,000.00$90,000.00
3$9,562.50$4,562.50$5,000.00$85,000.00
4$9,309.03$4,309.03$5,000.00$80,000.00

 

#PaymentInterestPrincipalBalance
17$6,016.67$1,016.67$5,000.00$15,000.00
18$5,760.42$760.42$5,000.00$10,000.00
19$5,506.94$506.94$5,000.00$5,000.00
20$5,253.47$253.47$5,000.00$0.00


This structure reduces the cost of ownership because you pay down the principal on your loan more quickly, reducing total interest paid over the life of the loan. Based on our original example, the cost of ownership using a decreasing payment schedule is around $153,615 – a savings of more than $8,400 over even payments.

Other Considerations

The interest owed to your lender is based on the loan’s outstanding principal. The quicker you pay down your principal, the less interest you owe. Therefore, you can reduce the amount of interest owed by increasing the frequency of your payments.

In the charts, you can see how increasing your payment frequency can reduce the cost of ownership for both even and decreasing payments. If your operation can handle more regular payments, it may be a good option to reduce the overall loan cost.

Payment Schedule (Even)Cost of OwnershipSavings
Annually$162,020.00--
Semi-Annually$160,870.00$1,150.00
Quarterly$160,300.00$1,720.00
Monthly$159,915.00$2,105.00

 

Payment Schedule (Decreasing)Cost of OwnershipSavings
Annually$153,615.00--
Semi-Annually$152,350.00$1,265.00
Quarterly$151,715.00$1,900.00
Monthly$151,290.00$2,325.00


The term of your loan also influences the cost of ownership. A 22-year term loan is common for agriculture real estate, but you may have the option to increase or decrease the life of the loan. In the chart, you can see how much the loan term affects the cost of ownership.

TermCost of OwnershipSavings
30-year$197,440.00--
25-year$179,280.00$18,160.00
20-year$162,020.00$35,420.00
15-year$145,715.00$51,725.00


Longer land loans typically make sense when cash flow is a concern. Your regular payments will be smaller, but you end up paying more interest. If your operation can handle larger payments, decreasing the loan term will save you money on interest and can often help you lock in a lower interest rate. For more on interest rates, review our article on how to get a better land loan rate.

Summary

Understanding the factors that affect the cost of borrowing money can help you negotiate a favorable land loan when you meet with your lender. Be sure to ask your lender about the options available to you so you can find the best structure for your operation.

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