Structuring Seller Financing: Rate, Amortization, Balloon

A bank hands you a rate sheet. A seller who carries the note hands you a blank page, and most buyers waste it by copying bank terms onto it. The point of seller financing is that every term is negotiable, and each one has a dollar value you can calculate before you sit down.

The worked example in this post puts three structures on the same $200,000 rental. The offer with the highest price, $215,000, turns out to be the cheapest for the buyer: $284,797 paid in total over ten years against $326,000 for a full-price offer at a higher rate. Price is the lever sellers watch. It is rarely the one that matters most.

When sellers say yes: the situations that create carry deals

Most sellers want cash, and no structure changes that. Carry deals come from a short list of situations, and your first job is to find out whether you are in one.

• The property is owned free and clear. This is close to a requirement. A seller with a mortgage cannot simply carry a note, because their own loan's due-on-sale clause is triggered by the transfer. That situation is a wrap or a subject-to purchase, which has different risks and is covered in how to analyze a subject-to deal.
• A landlord who wants the income without the tenants. Someone who has lived on rent checks for 20 years does not want a lump sum sitting in a savings account. A monthly payment secured by a house they know is a familiar asset.
• A large taxable gain. A long-held rental sold for cash puts the whole gain in one tax year. An installment sale spreads it.
• A property banks will not finance. Deferred maintenance, mixed use, an odd lot, a condo project that fails lender review. The buyer pool is cash only unless the seller carries.
• A stale listing. A seller who has held firm on price for months may trade terms to get the number.

Sellers say no when they need the proceeds for their next purchase, when heirs want to cash out, or when they do not trust the buyer to pay. The first two you cannot fix. The third you can, and the last section covers it.

The four levers: price, rate, amortization, balloon

Every carry deal is built from four terms, plus the down payment that secures them.

Price sets the note balance and is the number the seller tells their friends.

Rate sets how much of each payment is the seller's income. It is the seller's yield and your cost.

Amortization sets the payment size. A longer schedule, or interest-only, lowers the payment and leaves more balance owed at the end.

Balloon sets the date the remaining balance comes due. It does not change the payment at all. It changes how much time you have to refinance or sell, and how much risk you carry while you wait.

The down payment is the seller's protection. A buyer with 10% in the deal is less likely to walk, and the seller who has to take the property back keeps that money.

Here is how rate and amortization move the monthly payment on a $180,000 note:

One point of rate is worth roughly $105 to $120 a month on a 30-year schedule. Going from 20-year to 30-year amortization is worth about $200 to $230. If your deal is $150 a month short of working, the table tells you what to ask for.

On the balloon, the rule of thumb is to ask for more time than you think you need. Five years sounds long and is one bad lending window away from a forced sale. Seven to ten is safer, and an extension option, such as the right to extend for a year in exchange for a fee or a rate bump, is worth asking for in every offer.

Trading levers: pay their price, name your terms

Sellers anchor on price. Buyers should anchor on total cost and monthly cash flow. That mismatch is what makes a trade possible: you give on the term they care about and take on the terms they barely notice.

Compare two offers on a $200,000 asking price, both with 10% down, 30-year amortization and a 10-year balloon.

Offer Y pays $15,000 more for the house and costs $33,346 less over ten years. The payment is $274 a month lower, and the balloon is smaller because more of each payment goes to principal at the lower rate. These totals are undiscounted. Offer Y costs $1,500 more at closing and less in every month after that, so discounting does not change the ranking.

Three cautions on overpaying. A higher recorded price can raise your assessed value and transfer taxes. If you sell early you owe more, because Offer Y's note starts $13,500 larger and does not fall below Offer X's balance until year nine. Check the balance at your likely exit date and not only at the balloon. And the rate cannot go arbitrarily low: when a note's rate is below the IRS applicable federal rate, the tax rules impute interest to the seller. The seller's CPA should check that rate for the month of the sale before anyone signs.

Worked example: three structures on the same $200,000 property

This is an example. The property is a single family rental asking $200,000. Rent is $2,000 a month and operating expenses are $700, so NOI is $1,300 a month, or $15,600 a year. For a baseline, a bank loan with 25% down at an example rate of 7.5% over 30 years is a $150,000 loan with a $1,049 payment.

Each structure targets a different seller.

Structure 1, the income seller. Full price, 10% down, 7% interest-only, 10-year balloon. The seller's note pays $1,050 a month and the principal stays intact, which is what someone replacing rent checks wants.

Structure 2, the price seller. $215,000, which is above asking, 10% down, 4% on a 30-year schedule, 10-year balloon. The seller gets the number.

Structure 3, the tax-spread seller. Full price, only 5% down, 5% on a 25-year schedule, 15-year balloon. Little principal arrives in year one, and the rest comes in slowly.

Returns here are on the down payment only, before closing costs. The full return math on carry terms is in cash-on-cash with seller financing.

Now the seller's side, through each balloon date:

The price seller collects the least money of the three and got the highest price. That is the trade from the last section, shown from the other chair.

On the tax spread: suppose the seller's basis is $80,000, so the gain is $120,000, or 60% of the price. Under the installment method, roughly 60% of every principal dollar received is gain. In year one the seller receives the $10,000 down payment plus $3,921 of principal, or $13,921, and recognizes about $8,353 of gain instead of $120,000. Depreciation recapture has its own installment rules, so the seller's CPA runs the real numbers. Your job is only to know that low down and slow principal is what this seller is shopping for.

The balloons carry different risk. To refinance at 75% loan-to-value, Structure 1 needs the house to appraise at $240,000, which is 20% above today's price, or about 1.8% growth a year for ten years. Structure 2 needs $203,223. Structure 3 needs $139,528. Interest-only keeps the payment low and carries the most refinance risk, so pair it with the longest balloon and an extension option.

Paper and protection: notes, deeds, and servicing done right

The documents are standard, and a real estate attorney or title company in the property's state should prepare and close them. In general terms:

• Promissory note. The debt itself: amount, rate, payment, balloon date, late fees, grace period, prepayment rights, default terms.
• Mortgage or deed of trust. The recorded lien that secures the note. Which one is used depends on the state.
• Deed. Title transfers to you at closing. Under a contract for deed or land contract, the seller keeps title until you finish paying, which leaves the buyer in a much weaker position. Prefer a deed with a recorded lien.
• Title insurance. Buy an owner's policy. A seller willing to carry paper is not proof of clean title.
• Hazard insurance. The seller is named as mortgagee, the same as a bank would be.

Use a third-party loan servicer. For a small monthly fee the servicer collects payments, keeps the amortization record, can escrow taxes and insurance, and issues year-end interest statements to both sides. It removes every future argument about what was paid and when, and it makes the note easier for the seller to sell later.

Terms worth negotiating into the note: no prepayment penalty, an extension option on the balloon, a right of first refusal if the seller ever sells the note, and written notice with a cure period before any default.

Federal and state consumer lending rules can apply to seller financing when the buyer will live in the home. An investor buying a rental is usually outside them, but that is the attorney's call to make, not yours.

Presenting the offer so a seller actually considers it

Start with a question, not a term sheet: what will you do with the money from the sale? The answer tells you which seller you have. "Put it in the bank and live on it" is an income seller. "My accountant is worried about the tax bill" is a tax-spread seller. "I need $200,000, period" is a price seller.

Then present it the way the seller will evaluate it.

1. Offer two or three versions side by side: a cash price, and one or two terms offers. A lower cash number next to a higher terms number makes the choice concrete.
2. Speak in the seller's figures. Monthly income, total collected, and what secures it. Lead with the $1,050 a month, not with your cash-on-cash.
3. Keep it to one page. Price, down payment, rate, payment, balloon date, servicer, and who prepares the documents.
4. Answer the trust question before it is asked. Bring a credit report, a schedule of properties you own, references from other sellers or lenders, and the name of the servicing company.
5. Invite their CPA and attorney in early. A deal their advisor explains to them closes. A deal their advisor first sees at signing dies.

Before any of that, model your versions. Every structure in this post is three inputs in the single family calculator: rate, amortization and balloon. Run each offer, confirm the cash flow and the balance at the balloon date, and walk in knowing which lever you can give and which one the deal cannot survive without.