The "Infamous" Balloon Payment...

NOTE: This post is being updated due to a typogrphical error in one of our examples below...

This post will deal with whether or not you add a Balloon Payment provision when structuring a seller financed real estate note or contract.

The obvious reason that a balloon payment is made part of a note or contract is to force the buyer to get refinancing, and for the seller to get his/her cash sooner than 15, 20 or 30 years.

In a vast majority of the notes that we evaluate, the seller makes the balloon term too short... many of them are 3 to 5 years. If the seller plans on keeping the note until the balloon becomes due, a short balloon term of 3 to 5 years just doesn't give the buyer enough time to clean up credit issues in order to qualify for conventional financing.

If the seller plans on selling the note to an investor, let's say, after 12 to 18 months of seasoning, then the short balloon term drastically lowers the value of the note or contract, and the amount of cash the seller will receive at closing.

For example... let's take a note structured as follows:

Sales Price: $170,000.00
Down Payment: $25,500.00 (15%)
Original Note Amount: $144,500.00
Interest Rate: 8.50%
Term: 20 Years
Monthly Payment: $1,254.00
Payments Made To Date: 18
Note Balance: $140,092.41
Payor's Credit: Good – 700 FICO

Using the same note, as structured above, here's the difference in cash pay-out on a 3-year balloon versus a 10-year balloon...

On the 3-year balloon, we could only do a PARTIAL purchase of the remaining 18 months and 50% of the balloon, for a total purchase of only $75,393.50.

On the 10-year balloon, we could do a FULL purchase of $93,546.91 (33.2% Discount).

With NO balloon, we could do a full purchase of $98,165.02 (29.9% Discount).

So, as you can see, the term of the balloon can have a huge affect on the amount of cash received if the note holder decides to sell the note or contract.

The bottom line is... if you plan on selling your note or contract, and you simply must have a balloon provision, then make the balloon term 10 to 15 years.

We recommend having NO balloon payment if you plan on selling the note or contract.