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Updated about 8 years ago, 11/08/2016
How does the balloon work in Seller Financing
I'm starting to learn about seller financing in the hope of doing a deal soon. Let's say the terms are that the loan amount is amortized over 30 years, but the length of the loan is five years with a balloon at the end. Let's just say the loan is 100k and there is a 10% interest rate. Obviously during the 5 years payments are being made to the seller the interest is being paid on those payments. What about the balloon? How does the interest work when it comes to the balloon? I am terrible at math and am having a hard time conceptualizing this. Also, not finding any helpful calculators online to let me figure this out easily.
Anyone have any tips or advice for a buyer utilizing seller financing?
http://www.timevalue.com/products/tcalc-financial-...
As soon as I posted I found a good calculator. I wanted to post it in case others have the same question.
Would still appreciate any and all advice re being a buyer in a SF deal!
Balloon simply means the loan did not fully amoritzed at maturity. In this case your balloon payment on the example provided would be $96,502 in year 5 (maturity) because it was amortized to be paid off in 30.
Just wanted to make sure I wouldn't have to pay the full interest on a 30 year loan in the balloon!
@Samantha Soto The balloon isn't at the end, it comes earlier. It is put in play to gain time, to improve the cash flow and, hopefully, be ready for with more valuable property, when the reset comes due. Here is an example I am living with: an under-performing property was funded with a note that calculated the monthly payment over a 20 yr payback period, an interest rate, and a down payment. The payments are $603/mo. and it had cash flows from day one; but I knew that it could do better! It has a balloon in 5 years. Between now and then, I will make improvements to raise the rents, or lower the expenses, to increase the cash flow. At the 5 year mark, I must pay the note in full, what ever loan balance remains. It should be ready to re-fi because of my improvements. I will find a new lender willing to re-finance the property, paying the original note with the new loan proceeds. Or, maybe to negotiate with the same lender with new terms. My goal is to always be cash flowing. Or, I could sell the property before the 5 year mark and pay off the balloon with the proceeds of the sale.
The beauty of seller financing is that the terms are set by the two parties negotiating. To understand the math, write out the terms on paper to see what it looks like. This will be a thinking paper showing a various options. This paper could also be presented to the seller. The balloon is placed with enough time to re-position, or, to ride market appreciation (riskier).
Just because you get seller financing on a property, it doesn't mean there has to be a balloon. I signed a 36 year fully amortized note on a house a woman in her 60s sold me. The terms are all negotiable and I suggest you negotiate extensions if the seller insists on a balloon. You're likely not going to be able to find financing to pay off the note and you may not want to sell so quickly. A few extensions built into the note will give you more time to enjoy the ride.
I'm learning so much just from analyzing this deal! @Kathy Henley I actually made a spreadsheet tonight laying out different terms. That was great advice because the spreadsheet was incredibly helpful. @Aaron Mazzrillo I hadn't considered going longer than 5 years but I will run some calculations to see how that would play out for our numbers. Thanks for the tips!
Go to Staples and pick up a (Hewlettt Packard) HP 10Bii financial calculator. (Or just get one off Amazon.) Order the book Invest in Debt by Jimmy Napier. Try to buy an updated version. I believe Gary Johnston sells them now. The old book is a bit confusing because it was written for the older calculators so there was an extra step that is no longer required.
It is a short book and you can sit down in a few hours and go through the whole thing. You might even consider Gary Johnston's Financial Freedom course or any of his calculator classes. He comes to Orange County once or twice a year to teach. You get lots of calculator problems to work on and you'll learn an unbelievable amount of information about the financial calculator. It was definitely one of the best courses I've taken. It is definitely not a "seminar." You get to do lots of work just like the good ol' days of being in school. You'll also get to meet his friend Clyde who does a little bit of presenting. Clyde is an amazing human and he is one of the nicest people. I won't say too much about him other than he's quite the character and getting to know him absolutely changed my perspective on investing in real estate.