Four Ways to Minimize the Impact of Balloon Payments

In a previous article, I shared the first five of the techniques I teach Realtors to help them see the potential when it comes to seller financing. [Real Estate Paper: Your Most Valuable Tool].

When investing in real estate notes, there are options available to avoid balloon payments. Balloons have been called "foreclosures in embryo." These four techniques are ways to avoid or minimize the impact of balloon payments.

1. Balloon payment extension rate

Instead of a balloon payment, the interest rate could increase at a certain time. For example, at 60 months, the 10% interest rate may jump to 15% or some other rate. What would the seller do with the cash if he or she were paid off?

Plug into the note a rate that might make the seller happy with their rate of return. A higher rate may encourage the buyer to refinance, which would accomplish the same purpose.

2. Balloon payment--sell the note

Five years into the note, the note may be well seasoned with a good payment history. At that time, the note could be sold for cash to a paper investor.

If there were originally a balloon, it could be structured that with a good payment history and an acceptable loan to value (LTV) ratio based on current property values, the note could be extended for another five years.

This seasoned, short-term real estate note with a good payment history could be sold for little discount.

3. Bubbles instead of balloons

A small balloon payment for less than the full amount of the note is sometimes referred to as a bubble. What are the seller's needs? Could smaller lump sum payments over a few years meet his needs?

As a note broker, it is sad to see sellers sell a large note and take a big discount just to get a small amount of cash. At other times, sellers receive balloon payments then turn around and put it in the bank at half the rate they were getting on the note.

4. Partials instead of balloons

One way for a seller to receive cash is to arrange to sell the next few years worth of payments to a paper investor instead of a balloon payment in 60 months.

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