Seller carry note with a 24 month balloon on a house I'd be living in for 24 months

Been reading notes for a year and this is the first time the paper is mine, and of course it's the paper that's the problem.

House is a 1,650 sq ft two story in a first ring suburb, dated but sound. Price $240k. Seller will carry $180k at 6.5% interest only, balloon at 24 months. I'd put $60k down and have about $55k left for work. Finished comps are $355k to $365k on the same block.

The intent was a live-in flip. Move in, do kitchen, two baths, floors, exterior paint over 24 months, sell after the two year residency mark so the gain qualifies for the primary residence exclusion.

Here's what I actually found in the draft note. The balloon is 24 months from closing. My residency clock is also roughly 24 months from closing. So the note comes due at almost exactly the moment I become eligible, and a house does not sell in zero days. There's also a prepayment provision, six months of interest if I pay off inside the first 12 months, which doesn't bite my plan but tells me who drafted this. No extension option written anywhere. There's a due on sale clause that's standard and a late fee I don't love.

If I can't sell in the 30 days between eligibility and the balloon, I'm refinancing a house I intend to sell, at whatever rates are then, with closing costs on a loan I'll hold for two months.

What I'm weighing: ask for a 30 month balloon and probably pay for it in price or rate, ask for a written extension option at a stated fee, or just plan to refinance and price that in. Seller's agent says the seller wants the paper gone in two years and won't move. I don't know if that's true or a first position.

Answer

1ehernandez74PO2BPRO5

Ask for the extension option and pay for it now, in writing, inside the note.

Reasons, in the order I'd give them to the seller. One, it costs them nothing today. Two, it gives them a fee if it's exercised, which is a better outcome for them than a borrower scrambling. Three, they keep the 24 month date as the default, so the thing they said they wanted stays true on the page.

Language I'd want: a single 6 month extension at the borrower's option, exercisable by written notice 60 days before maturity, for a stated flat fee, with the rate unchanged. Flat fee matters. A rate bump on an extension is where these get expensive.

On the timing itself, don't build a plan where two clocks land on the same week. Your residency date isn't necessarily the closing date either, it's tied to ownership and to when you actually occupied, and those can differ, so get your own dates confirmed by a CPA rather than assuming they're the same day. If your eligibility lands 10 days later than you think, a 30 day window becomes a 20 day window.

The other thing your post skips. You have $55k for work and no reserve. Interest only at 6.5% on $180k is $975 a month before taxes and insurance, and you're carrying that whether or not the kitchen gets done. I'd take $8k out of the reno budget and call it untouchable, then scope the work to $47k. @cobalt is right that the last room runs long, and running long with no cash is how people refinance badly.

The extension is cheap. Buy it.

10 replies

1dpatel_reCS4A

Price the three options and the choice makes itself. A 30 month balloon at a quarter point higher on $180k costs you roughly $1,100 over the life. A refinance you hold for two months costs you origination plus title plus appraisal, realistically $4,000 to $7,000 depending on your market, plus the risk that you can't qualify at that moment because you've been paying interest only and your income documentation looks however it looks. The extension option is the cheapest of the three if you can get it priced as a flat fee. You're being asked to choose between a known small cost and an unknown medium one.

4mitchell_ray4 Get yoursPRO6

55k for kitchen, two baths, floors and exterior paint on a 1,650 sq ft house is thin unless you're swinging the hammer. What are you doing yourself?

1laurenkim53Passive

Sellers who say they want the paper gone in two years usually mean they want to know it ends. A written extension at a stated fee gives them an end date they can see, it just moves it. I'd try that language before I'd try changing the balloon, because it sounds like less of a change even though it does the same thing.

1angela_burkeServicePRO6

Also, 30 days to sell a renovated house assumes it's renovated. Are you going to be done at month 22? Every live-in flip I've watched runs long because the owner's living in it and the last room is always the one they use most.

3chriswalton8CC1CPRO8

The prepayment clause reads to me like a template someone pulled rather than a seller with a strategy. If the whole note is boilerplate, the seller may have no attachment to the 24 months at all and the agent is guessing. Ask the agent one direct question: is the 24 months something the seller stated, or is it what the form said? You'd be surprised how often it's the second.

1nataliehsuSO1BPRO7

Dumb question, if the note comes due and you can't pay, what actually happens? Does the seller just take the house back? That seems like a big deal to gloss over.

2tylerbrooks9PassivePRO5

@plumb the remedy depends on how the security instrument is written and what state it's in, because foreclosure process and timelines differ a lot state to state. It's a real risk, not a footnote. Vellum, that's the reason I'd want the extension in the note itself rather than a promise on a call.

3tashaford30PB2APRO7

@anchor's 60 day notice detail is the part I'd have missed. Every option I've read that had no notice mechanism turned into an argument about whether a phone call counted.

2nicole_adeyemiPassivePRO5

One more line to check before you sign: whether the note is assumable and on what terms. If a buyer at month 26 could take the paper at 6.5%, that's a selling feature in a higher rate market, and it also gives you an exit that isn't a refinance. Most seller carry notes I've read say nothing about it either way, which is its own problem. Have your attorney read the whole instrument, since what the security document allows varies by state.