What about equity? It can also make it hard for the buyer to obtain refinancing when the balloon is due if they haven’t built any equity. To make the balloon payment they will likely need to obtain refinancing in the future. Will they be able to afford going from interest only payments to a potentially higher amortizing payment that includes principal and interest? Big Mistake #3 – Buyer Can’t Make The Balloon PaymentĮventually the balloon payment will come due. It’s important to ask, will the buyer realistically be able to make the balloon payment when it comes due? In the current market an amortizing payment is preferable to the majority of note investors. If values decline it can quickly lead to the buyer being underwater, owing more than the property is worth. On the flip side the risk is increased when a buyer makes a low or no down payment with an interest only repayment plan. This high risk factor can be offset when a buyer makes a large down payment at closing. A buyer without equity or “skin” in a property purchase has a much higher likelihood of both delinquency and foreclosure. Since the payment is only covering the interest the buyer is not building equity through amortization. With an interest only payment there is no application to the principal. That means if the note fails to include the balloon date then it would never have to be paid off! Sellers and note buyers alike want to know that the buyer will eventually have to pay for the property they purchased. Each month the balance goes down and the note eventually pays off. When a note amortizes a portion of the payment goes to interest and a portion goes to principal. This means the repayment terms must state a date in the future when the full balance will be all due and payable. When a note calls for interest only payments the balance does not amortize. 3 Mistakes With Interest Only Balloon Notes When Owner Financing Big Mistake #1 – No Balloon Mortgage Date Unfortunately there are three common mistakes people unknowingly make with interest only (I/O for short) payments. If the buyer makes a payment that is more than the interest only portion then there is a principal reduction and the balance goes down. If the buyer pays just the interest every month then the balance stays the same and does not decrease. Learn More About Calculating Cash Flows What It All Means
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