A balloon payment is a larger-than-normal payment at the end of a loan term.
You might amortize a note over 30 years to determine the payment but make the note ‘due and payable’ at the 15-year mark.
Balloon Payments and Seller Financed Notes
Balloon payments in seller-financed notes are the answer to the questions of time and flexibility.
For the property buyer, seller-carried financing gives them time to build their credit score and create equity — something they need to obtain a home mortgage from a traditional lender. The motivation and deadline to refinance their home are there; they want to do it before the balloon date.
It also gives sellers wanting to offer owner-financing, but who are wary of the 20 – 30-year timeline, flexibility. They could provide owner financing with payments based on a 30-year amortization but a loan term of 10 to 15 years with a balloon payment to cover the remaining balance and interest.
Note Values and Balloon Payments
When looking down the road and wanting to protect the value of your real estate note, balloon payments can help.
Due to the time value of money principle, money due now is worth more than money due later. This allows investors to sometimes pay more for notes with a shorter term.
There are a couple of caveats.
First, it is best to avoid interest-only payments and agree on a monthly payment that allows for amortization with a portion going to principal and interest each month.
Second, look at structuring, so the buyer can repay the note and obtain third party financing at the end of the term.
Third, understand how changing laws and regulations might impact when and how balloon payments can be used.
Dodd-Frank Act and Balloon Payments
In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law.
And it changed the rules of loans to owner-occupied buyers in some significant ways, including some seller-financed notes.
Focusing on preventing homeowners from biting off more than they can chew, the Dodd-Frank Act added significant regulation and punishments for originators that created notes that went outside of “ability-to-repay” bounds.
When it comes to balloon payments, it tightened the rules on including balloon payments at the end of their loan terms. In today’s housing market, it’s crucial always to verify your note terms with an individual who knows the rules and laws.
Have questions about creating real estate notes for resale to investors? Contact Equity First Funding today.