A buyer wants me to carry on my aunt's house. Agreeing to what?

The 9k gap isn't the comparison. First year interest on 165k at 7.5% is around 12.3k, so on income alone the note passes the cash offer inside a year, assuming he pays.

That assumption is the whole thing. 20k down on 185k is about 89% of value out the door on day one. If he stops paying in month 14 you're taking the house back with almost no cushion, and whatever he did or didn't do to it in the meantime is your problem. I'd counter on the down payment before I counter on the rate. 15% down changes your position more than another half point of interest does.

Before any of the structuring, find out exactly why the lender said no. "Self employed, income docs" covers a guy with real money and messy returns and it also covers a guy with no money. Ask for two years of returns and bank statements and read them yourself. If he won't hand them over you have your answer.

Also, five years goes slow when you're the bank and fast when he owes you a balloon he can't refinance.

Mechanics, since nobody's said them yet. A real estate attorney in your state drafts the promissory note plus the security instrument, which is a mortgage in some states and a deed of trust in others, and the difference matters because the default process is different. That's an attorney question, not a forum question.

The security instrument gets recorded so your lien shows up against the property. Then you hire a licensed loan servicer. They collect, they send him statements, they produce the payment history in a form somebody would later accept if you ever sell the note. Have them escrow taxes and insurance instead of trusting him to pay both, and have the insurance policy name you as mortgagee so you get told if it lapses. Ask the attorney to confirm current requirements in writing for your state before closing.

Your payment number is right, 1,153.70 at 7.5% on 165k over 360 months. Balance at the year five balloon is roughly 156.1k, so he'll owe you about that in a lump and will need to refinance or sell to pay it.

One number to hold onto: if your rental plans move up and you want the cash early, you'd be selling the note, and a buyer pricing to a double digit yield on a five year balloon pays somewhere in the mid to high 80s of the balance depending on the payment history and the collateral. Call it a 20k haircut on a 156k balance. So the note is worth face to you only if you actually intend to sit for the five years. If you don't, take the cash.

One small thing from the property side: whoever services it should be checking that the insurance is still in force every single year, not just at closing. Lapsed coverage on a house you have a lien against is how a small problem becomes an uninsured one.