Balloon in five years, or amortize the whole thing and just collect checks?

The thing that made me stop liking short balloons is that you don't control whether the refinance is available. You control the term, the rate, the down payment. You don't control what lending looks like in 2030. So a two or three year balloon is basically a bet on someone else's underwriting standards, and if you lose the bet, the person holding the bag is you, not the buyer.

I came into this wanting income without a second job, and a balloon sounds like a second job with a due date. If I wanted my principal back at year five I could just sell for cash now.

Read the balloon clause and the default clause together, because that's how they actually operate. Most notes I've read treat failure to pay the balloon as an ordinary default, which means the balloon date is a foreclosure trigger sitting in your contract on purpose. Some notes add an extension option, sixty or ninety days, sometimes with a fee, sometimes at a bumped rate. Some let you extend at your sole discretion, which is the version I'd want because it turns the hard date into a decision instead of an event.

Also check whether the note says the balloon is the entire unpaid balance plus accrued interest and any advances you made for taxes or insurance. If it doesn't spell out advances, and you paid a tax bill to keep the county off the property, you can end up arguing about what the payoff number even is. Foreclosure procedure and timelines vary a lot by state, so the practical cost of that balloon date is different in Texas than it is in New York. An attorney in the state where the property sits is the only person who can price that for you.

Question from the cheap seats: if you write a 30 year amortization with no balloon, can't you just sell the note later if you want the money out? Or does that get you a haircut big enough that you'd rather have written the balloon?

@kestrel you can sell it, and the haircut depends on what you wrote. A note buyer prices off the rate, the seasoning, the borrower's payment history, the equity behind it, and the documentation. A 30 year at a rate below what note buyers want yields at will discount hard. A note at a market-ish rate with two years of on-time payments and a real down payment behind it discounts a lot less.

So the balloon isn't your only liquidity plan, but you don't get to write a soft note and expect a clean exit. I underwrite these the same way I'd underwrite anything else: the terms are the asset, and you write them once.

Middle ground nobody voted for yet: ten years. Long enough that the buyer has real time to fix credit or season income, short enough that you're not committing your rate for three decades. I've done it on the buy side and it never felt like a countdown.

From five years of running a business on other people's payment schedules, the number that matters isn't the balloon date, it's whether the monthly payment is comfortable for the buyer at month forty. People don't miss balloons out of nowhere. They get tight, they start paying late, and then they can't get a lender to look at them because the last twelve months of their credit report is a mess. If the payment is right, the refinance usually works. If the payment is a stretch, the balloon was always going to be a problem.

@thatch that reframes it for me. So the amortization schedule you use to set the payment matters more than the term you use to end it.

Notes have mostly confused me the past couple of months, but this thread finally made one thing click. The balloon is a call option you're writing into your own income stream, and the price of that option is the chance the buyer can't perform on the day it comes due. @arbor if you actually want the income, I don't see why you'd write the option at all. If you want the principal back, you want a shorter note with a bigger payment, not a long note with a cliff in it.