When a performing note has a balloon and the borrower clearly cannot refinance, do you price to the balloon or to an assumed extension?

The two numbers are both real, and neither one is the number. The bid has to reflect the probability-weighted blend of the two outcomes, which means you need an estimate of how likely the balloon is to actually close out versus roll into an extension.

Here is how I think about structuring that estimate. Start with the collateral. If the property value gives the borrower a clean refinance path at a higher rate, even an uncomfortable one, the balloon resolves more often than intuition suggests, because borrowers find a way when the alternative is losing the house. If the loan-to-value ratio (the loan balance divided by what the property is worth) is tight or the property has problems, a conventional lender will not touch it regardless of the borrower's credit, and the extension scenario becomes more probable. So the collateral is doing as much work in this pricing question as the credit profile.

On who controls the modification: most standard note forms give the holder discretion to modify, but that language varies, and some notes require the original lender's approval even after assignment or have due-on-sale clauses that complicate the chain. You need the actual note document to answer that, not the seller's summary. A real estate attorney familiar with note transactions should read it before you price the bid. I would not assume discretion.

Sellers rarely volunteer the modification language before you ask. In my experience of reading through how these transactions typically go, the disclosure comes after a specific document request, not before. Asking for the full note, the allonge (the document that records assignments), and any prior modification agreements as part of your initial due diligence package is the standard move.

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What does the current LTV look like on this note?

The assumption doing the most work in your model is that the balloon triggers a clean binary: payoff or foreclosure. The extension scenario breaks that assumption, and you are right that it compresses yield significantly. Two percentage points over a multi-year extension is not noise, it is the difference between a viable bid and a charitable one.

On the modeling question: price to the extension, not to the balloon. Here is why. A borrower who cannot refinance at today's rates almost certainly cannot refinance at rates that are marginally better either, which means the balloon date is a fiction for pricing purposes. You are effectively buying a longer-duration asset than the note face suggests. The question is what yield you need to accept that duration, and that number should anchor your bid, with the balloon-date yield treated as a ceiling you probably will not reach.

The note language question is the right one and it almost never gets disclosed proactively. What you are looking for is whether modification authority sits with the holder unilaterally, requires a formal forbearance agreement, or is constrained by any servicing agreement that travels with the note. If the note was originated inside a pool or has ever been securitized, there may be a PSA that limits what the current holder can actually do without consent. That language, if it exists, constrains your flexibility more than the borrower's credit does.

On seller disclosure: in my experience reading through these threads, sellers rarely surface the modification language before the question is asked directly. Some do not know it. Some do know it and are pricing to the balloon because it flatters the yield. Your due diligence request should specifically call for the original note, any allonges, any servicing agreement, and any recorded assignments, before you run a final number.

A licensed attorney familiar with note transactions should review the modification and consent provisions before you close. That is not optional on this structure.

What is the LTV on the underlying collateral, and have you pulled the borrower's payment history past 12 months?