An investor in Milwaukee recently bought a small rental home for $45,000 by putting on a new first of $25,000 and having the seller "carry back" the rest (no payments, no interest) after a small down. The seller would do so only after the real estate investor agreed to pay out the indebtedness after five years.
The real estate investor of a $235,000 6-plex in Lake Worth, Florida, assumed the existing first and induced the seller to carry back the remainder of his equity after the $50,000 down payment (obtained from a partner) in the form of a second at 12%. The seller agreed, but only on the basis of a ten-year payout of the balance of the second. Both of these investors were using the technique referred to as a "balloon mortgage".
It is not uncommon for seller-financing arrangements to include provisions for a balloon payment in the future.
In fact, balloons are an important inducement to get the seller to play the part of the lender in the first place. Knowing that the major part of his equity is coming in the near future, the seller is willing to carry the financing at rates below the conventional market.
Occasionally a seller is willing to amortize the entire amount of the carry back over a long period of time - fifteen or twenty years or longer. Most of the time, however, the seller wants to be paid off sooner, in fact, as soon as possible.
That is the danger the real estate investor must beware of - short-fuse balloon notes can rob the real estate investor of health, sleep, and sometimes the real estate property itself.
In theory, the time of the balloon payment should be far enough away to take advantage of interim appreciation. real estate property values and rents must grow enough to permit a refinance solution to the balloon payment.
What if local real estate property values - particularly during a period of sustained high interest rates and sluggish real estate sales - do not grow as anticipated?
The real estate investor may be forced to sell the real estate property, or another piece of real estate in his control to pay off the balloon.
He may have to bring in an equity-participation cash- partner to bail him out, thus giving away important benefits.
The worst case, he might have to give the real estate property back to the seller and lose all his investment.
Despite the risks, the balloon payment technique can be a valuable way to get into a real estate property for little or nothing down up front.
Real estate investors should resist pressures to accept anything less than five years for payout seven years or more would be preferable.
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