Top 5 Things to Avoid When Adding a Balloon Payment to an Owner Financed Note
05/12/2010 Should you add a balloon mortgage payment to an owner-financed note? It can improve the value of the note, so it's not a bad idea. But it can be if you don't know how to reduce the risks associated with this type of mortgage note addition. Any of the factors listed below can cause problems when the balloon payment comes due and the buyer tries to refinance. If that happens, the note seller or buyer could face an increased chance of delinquency or foreclosure. To keep owner financing a positive experience for everyone involved, avoid these common balloon mortgage mistakes:
5. Too short of a term A balloon payment due in fewer than 36 months may not allow sufficient time to rectify bad credit and other issues that may disqualify the buyer from obtaining a traditional loan at closing. A better approach is allowing a 5-, 7- or 10-year term. 4. Not requiring a down payment Not requiring a down payment may lead to a situation in which the buyer doesn't have any equity in the property when it's time to refinance. Without equity, the buyer will have a difficult time finding a lender willing to approve a new mortgage.
3. Allowing interest only payments Allowing the buyer to pay accrued interest but not capital doesn't decrease the principal balance or increase equity. Equity could build if the property appreciates, but appreciation isn't guaranteed. A better option is monthly payments based on a 20- or 30-year amortization and a large payment due on a balloon date. This achieves two goals. First, it lets the buyer build equity. Second, it helps the buyer get used to making mortgage payments that are more in line with a future lender's requirements.
2. Underestimating a buyer's credit problems It can take many years to rebuild damaged credit to the point where it can qualify a buyer for a traditional mortgage. Realize that rather than a few years, rebuilding credit and improving credit scores could take anywhere between seven and ten years.
1. Property That's Difficult to Finance Property that's difficult to finance now probably will still be difficult to finance later on. If an honest evaluation reveals that financing through a conventional bank will be challenging, consider a short-term fully-amortized schedule for repayment.
Owner-financing with a balloon payment is a great way to maintain flexibility and increase the note's value. That's why it's so important to avoid these common balloon payment mistakes.
