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Owner Financing – Why Balloon Payments are Good for Mortgage Notes

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A balloon payment is a common addition to an owner-financed note, mortgage, trust deed or land contract. Savvy sellers, real estate professionals, and note brokers know this is by design rather than accident. Here’s why balloon payments can be good for mortgage notes:

(Editor’s Note: Please be sure to read the updated comments at the end of this article pertaining to changes in market conditions related to balloon payments since this article was initially published.  Also refer to How Dodd Frank Laws Apply to Seller Financing).

Benefits of Balloon Payments with Seller Financed Notes

Purchaser Buys Time

When a seller offers owner financing it allows the buyer to not only purchase the home but also buy some time. The buyer has the opportunity to build equity, establish a payment history, and improve their credit rating, important factors in obtaining a home mortgage loan from a lender.

While a fully amortized note allows for repayment in substantially equal payments over time, a balloon clause results in a large payment on the balloon date that will pay off the remaining balance plus interest. Including a balloon payment provides the motivation in addition to the time a buyer may need to qualify for bank refinancing.  Instead of refinancing when they get around to it, the buyer has a deadline to meet in the form of the balloon date.

Provides Seller Flexibility

Sometimes it is hard to know what life will bring next year let alone in two or three decades. While accepting payments from the buyer might provide a necessary solution, waiting 20 to 30 years for payment in full can be a long time.

Even if a seller is comfortable waiting out the full amortization period at closing, time has a way of changing circumstances and needs. Including a balloon payment to shorten the term to 5, 7 or 10 years can provide flexibility and peace of mind to the seller. If the seller still desires the monthly payments and interest income they can always agree to extend the balloon payment for the buyer.

Improves Note Value

One of the best reasons to include a balloon payment when using owner financing is the increased value to investors.  Should the note holder ever decide to sell the payments for cash, a note buyer can usually pay more for a balloon note than a fully amortized note. This is due to the time value of money concept making money due now worth more than money due later.

To illustrate, if a seller agreed to owner finance $200,000 at 8% interest for 30 years the buyer would make payments of $1,467.53 each for the next 360 months. If an investor were willing to purchase this note for a 9% return the seller would receive approximately $182,387.

Now look what happens if the note is written to include a balloon payment with the balance all due and payable in five years. The investor could now pay $192,138, almost $10,000 more, and still achieve a 9% yield.

The payment, interest rate, and yield rate all remained the same. The only difference was the addition of a five-year balloon payment rather than allowing the note to fully amortize in 30 years. This one change has the potential to put almost 10 grand more in the seller’s pocket should the note be sold to a mortgage note buyer!

The increased value to an investor combined with the seller’s flexibility and the purchaser’s need for time all work together to make a balloon payment good for owner financed mortgage notes. But like most good things, a little can go a long way. Unfortunately many owner financed notes combine a balloon payment with high risk factors turning a positive to a negative as detailed in Owner Financing – Avoid 5 Balloon Mortgage Pitfalls.

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Comments

  1. I have a Balloon on a 30 year Mortgage. The seller is willing to remove the Balloon Payment and continue the same 30 year mortgage and interest rate. Is a NOTARIZED LETTER from the seller removing the Balloon sufficient or is there a requirement to draw up a new contract?

    • Hello George, Typically a modification is signed by all parties stating that the balloon has been removed and the new maturity date of the note. An attorney can assist with preparing the necessary documents. Tracy

  2. I want to help my son get back on his feet , I want to do a land contract, 20% down , 3% loan for 6 years on the remaining principal (estimated value of home, I own it free and clear). We agreed no payments for 6 years , as it’s a balloon , the principal and ALL interest (amortized over 6 years in a lump sum) will all be due at once after 6 years. These our the terms, doing the right thing by charging interest , yet differing to the end as a lump balloon along with the principal. Is that okay and acceptable with IRS as long as I claim the total interst on Form B with my tax return for the year I collected the lump sum in 2024? Or does interst havw to be broken down yearly? Will my son be able to use as a deduction of interst paid also ?

    • Hello Yosef, I am not a CPA or accountant so will let them answer the tax filing question. In addition to which forms you will want to be sure you are charging a fair market rate (see article here for details: https://turbotax.intuit.com/tax-tips/tax-payments/irs-tax-rules-for-imputed-interest/L7UbulHpC

      From an investor point of view we buy notes all the time with balloon payments. However, I strongly encourage you to require at least monthly interest only payments rather than adding it to the back or balloon payment. Without that your son could end up owing as much as or even more than the property is worth which would cause problems when he goes to refinance. Also, monthly payments will help him establish a payment history which will be valuable when he goes to refinance and payoff the balloon. There are third party servicing companies that can track the payments or their are services like ClearNow at https://www.clearnow.com/collect-seller-financing-mortgage-payments-online.php

  3. Hi, I am currently the lender in an owner financed home. The man who was buying the home left the home and his girlfriend who has stayed in the home and agreed to make payments and buy the home. He left 2 years ago and never told me this was happening and his girlfriend lied to me and told me he was just out of town alot so she had to take care of making the payments for him. Well now that the term is almost up, she tells me he actually left her two years ago and decided he didnt want the house and that she could have it an buy it. Now she is bothering me with needing more time to secure a loan. This really upsets bc i was lied to and now having to deal with the hassel. I have sellers remorse and just want my house back now. Can I file for repossession on my own without an attorney? Also, since her name is not on the contract, do I have to accept her money if she does get the loan, or can I take the home back? Any help would be appreciated as the real estate attorney wants to charge me 350.00 just to ask these questions and I’m just at a loss.

  4. I am planning to sell my house but due to its fair condition and loan balance, sellibg it straight may end up smaller rhan the balance and we will still owe something. I was then offered kinda like a balloon. They will be paying the mortgages, repairs and all. But the contract is that for the entire duration which is 3 yrs. The title will be under our name. Although we donot really have to do anything since everything will be done by them, mortgage, insurances and moving cost. Our only participation is that the property will be under our name. After 3 yrs, they will refinance and our name will be take off. Is this a good idea?

  5. ME AND MY FIANCE ARE WANTING TO PURCHASE A PROPERTY. (TO HELP US OUT THE OWNER IS GOING TO DO $ 30,000.00 AT 7 YEARS WITH A 6% INTEREST RATE AND ZERO $ 0.00 DOWN PAYMENT. THIS IS WITH THE CONDITIONS OF…..
    1. AT THE 5 YEAR MARK, ADDING AN ADDITIONAL $10,000.00
    2. FOR US TO PAY OFF IN FULL THE REMAINING BALANCE OF THE ORIGINAL NOTE (30,000 @ 7YRS) PLUS
    THE ADDITIONAL $10,000.00. THIS BEING WHETHER IT IS PAID IN CASH BY US (THE BUYER) OR TOOK TO A BANK AND GETING THE COMPLETE BALANCE REFINANCED THROUGH SOMEONE BESIDES THE ORIGNAL SELLERS.
    IS THIS DONE OFTEN BY OTHER SELLERS?
    WHAT PAPERWORK SHOULD I RECEIVE WHEN SIGNING THE CONTRACT? ( WARRANTY DEED, ETC)

  6. My husband and I had been house shopping for months. Our original loan expired and we were not approved when reapplied…we’ve found a house for sale by owner, but they don’t want to use an agent. We’re working on credit issues but as you can imagine that takes months. My question is if the owners were to agree to carrying contact with balloon note, how would we or could we go about that without an agent?

    • Hello Kara, You will want to work with a title company and real estate attorney in your county. Depending on your state either the attorney or the title company will usually draw up the closing documents (purchase agreement, settlement statement, note, mortgage/trust deed, warranty deed, and other documents depending on your situation).

  7. if the note is for 1 year with a balloon, does lender(not seller) required to send 60 day notice?

    thanks.

  8. I have a 36 month balloon term lot loan that is maturing this year (April). The current payoff of the loan would be $135,000. Since 2014, the value of the lot has gone up. What would be the benefit of refinancing this lot loan at $175,000 for another 36 month balloon term?

  9. what is the best way to protect a balloon payment from the tax man? Is it poszible to do a 1031 exchange with a ballon after a 7 year contract is satisfied?

  10. Hi Tracy,
    We own our house and have only owned for 2.5 years. We hanve moved away and have listed it for sale. We hanve received an offer to do $100k down, with a 5 year lease and a balloon at the end. This is uncharted territory and I’m wondering if you can help…is this good for us or not. We owe $280k on the home and have it listed for $400k.

  12. WE ARE OWNER FINANCING A PROPERTY AND THE TERM IS UP. THE BUYERS ARE WANTING TO EXTEND THE OWNER FINACNING ANOTHER 8 YEARS. WHO IS RESPONSIBLE FOR COST OF AN ATTORNEY TO DRAW UP THE EXTENTION?

    • Hello Shawn,

      That is negotiable between you and the buyer. I suggest that you have the buyers pay that cost. You are helping them out by agreeing to extend the financing longer and the cost of the extension is likely going to be less than a bank would charge for loan origination fees (and they definitely would pass on the cost to the borrower)! You could also use this opportunity to negotiate terms that are more favorable to you but still affordable for the payer. When considering balloon extensions you’ll want to be sure the extension does not impact your lien position and the ability to enforce the lien. Be sure to work with an attorney and title company to protect your interests.

  13. Informative discussion – For my two cents , people need to fill out a Freddie Mac 3291 , my colleague encountered a fillable document here https://goo.gl/QWLwbm

  14. We held a mortgage on a property that was to amortirize over 14 yrs…..the buyer wants to pay us off with 4 yrs. left on mortgage…….is that amount taxable to us?

  15. “The buyer has the opportunity to build equity, establish a payment history, and improve their credit rating”

    I totally disagree on this. The only way possible that this would apply, is if the seller reports to the 3 credit bureaus. I have never known that to happen. The mortgage company, lender or underwriter, is not going to just “accept” the sellers word they had a great payment history and in reality, it’s going to buy you nothing in the real world.

    Unless it is documented and reported, there is absolutely no way possible your credit score is going to go up because of it. For all practical purposes, this is off the books and nobody knows it exist. As such, you will receive absolutely no credit for it 🙂

    • Hello Louie, I agree that keeping a verifiable payment history is crucial to getting the full benefit of this strategy. The best option is to use the services of a third party servicing company that reports to the credit bureau. There are companies that will do this for seller financed notes. This article outlines the importance and methods of creating a payment history that can be validated: Note Buyers Love Payment Histories

  16. Almost 5 yrs ago I did an owner-financed sale with a balloon payment to an LLC. The buyer recently contacted me and said he would like to extend the balloon payment by about 6 months. I don’t really object to the extension; however, I do not know exactly how to proceed.
    Should I go back to the title company that did the original paperwork and have them finalize the new terms? Do they have the expertise to protect me with this or do I need to get an attorney (if so, what kind of attorney would that be?).
    The buyer has never been late on a payment but has at times let the taxes become delinquent. Perhaps incorporating the tax payments into the new payment amount would be a good idea.
    Any advice would be greatly appreciated.

    • Hello David!
      Great questions and you are definitely on the right track by going back to the title company or attorney to formalize the extension. I’m happy to share some thoughts based on our experiences but have to insert the fine print that I’m not an attorney so unable to provide legal advice.

      When it comes to extending the balloon I keep three things in mind:

      Get Realistic
      What is the likelihood the payer/buyer can repay? Extending a balloon when the buyer is making monthly payments can be much better than foreclosing. Most of us hold notes for the monthly cash flow and prefer not to own the actual property. Foreclosure can take quite a bit of time and expense so working with they payer/buyer can be a good option. In this situation think about if the payer can realistically pay in 6 months. If not, perhaps a longer extension might be useful to both of you so you are not having this conversation again in 6 months :). Find out the barriers for the buyer to paying the balloon off now and see where improvements might be made to change that later (is the issue income, value, credit, etc.)

      Make It Worth Your While
      The buyer will be saving money if they don’t have to obtain new financing right now. While having the relief of not foreclosing might be enough to compensate you for the extension also give some thought to whether an increase in the interest rate, an adjustment to payments, or working in the reserves you mentioned for taxes would make it worth your while.

      Protect Yourself With Legal Documentation
      Definitely document the extension with a modification to the note and mortgage as you mentioned. Changing the terms of the note has the potential to affect your lien position and enforcability – especially if there are junior lien holders. You will want to work with the title company or a competent real estate attorney to draw up the documents. Which one you use really depends on what is more customary in your state. It might also be good to update the lender’s or mortgagee’s title insurance policy with the modification.

      Hope that helps and thanks for reading and commenting at NoteInvestor.com

      Tracy Z. Rewey

      • I had thought that the Safe Act of 2008 and the Dodd Frank Act of 2010 had prevented balloon notes from owner financed mortgages. Judging from these comments I am guessing that is not true and a balloon note is allowed? Also, can the owner/mortgage holder foreclose on the property just due to the balloon note not being paid but all other provisions of the mortgage note were paid (taxes, insurance, monthly payments). And finally, can the owner/mortgage holder change the terms if the balloon is not paid to require higher payments and enforce that agreement if the mortgagee never signed the documents but actually paid the higher monthly amount due to threats by the owner’s attorney?

  17. If you owned a property free and clear would you lease it or sale it owner financed it.

    Thanks Greg

    • Hello Gregory! If I had confidence in the buyer I would personally opt for seller financing because I like the long term interest income. If I thought the buyer needed to first prove their payment habits I would consider the lease option first. However it depends on your ultimate goals. This article from our archives does a good job of weighing the pros and cons of the lease option vs. seller financing: https://noteinvestor.com/sellers-corner/lease-option-or-seller-finance/

    • Hello Marc and excellent question!

      From just a time value of money point of view balloon notes are more valuable. If it was based strictly on running a yield against a payment stream then a short amount of time would make the Present Value at the desired yield greater. However, the current market conditions have left it almost impossible for note payers to get refinancing – unless they are A+ credit, stable income, and great equity (which isn’t the standard owner financing buyer 🙂 ). So that means the chances of an investor actually receiving the balloon payment have gone way down.

      Some investors will still consider an offer but will assume the note amortizes rather than balloons when they run the yield against the cash flow. Other investors might want the balloon eliminated if they are concerned about it being made.

      Another reason some investors are nervous about balloon payments are some of the new regulations (from the HUD Safe Act and the Dodd-Frank Act) relating to disclosures and requirements for balloon notes. When creating new notes (with or without balloons) be sure to consult with an attorney.

      I know you are also in the seller financed note business. Are you experiencing similar changes in your business?