Adding a Balloon Payment to an Owner Financed Note

Should you add a balloon mortgage payment to your note? 

It can improve the value of the note, so it may not be a bad idea. However, it can be a dangerous decision. Read on to learn 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 mortgage 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 financing a positive experience for everyone, avoid these common balloon mortgage mistakes:

Too short of a term

A balloon payment due in fewer than 36 months may not allow enough time to rectify bad credit and other issues that may disqualify you from obtaining a traditional loan at closing. A better approach would be getting a 5-, 7- or 10-year term.

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.

Allowing interest only payments

Allowing the home 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 and second, it helps the buyer get used to making mortgage payments that are in line with a future lender's requirements.

Underestimating a buyer's credit problems 

It can take many years to rebuild damaged credit where it can qualify a buyer for a traditional mortgage. Rebuilding credit and improving credit scores could take anywhere between seven and ten years.

Property that 's hard to finance

Property that's difficult to finance now probably will likely 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 an excellent way to maintain flexibility as well as increase the note's value. That's why it's so important to avoid these common balloon payment mistakes.

Gretchen Wegrich

Gretchen Wegrich is an editor at Lender411. She specializes in mortgage basics, personal finance and green living. She graduated with a bachelor's degree in writing from University of California, San Diego and previously worked at the Santa Cruz Sentinel. Contact her at gretchen@lender411com.