Contract Durations and ‘Balloon Payments’

It’s quite common for Land Contracts and seller-financed Real Estate Purchase Agreements to have a contract duration of 3 to 5 years with a buyout clause — often called a ‘balloon payment’ — due at the end of that time.

Let’s examine why that structure is common, and why it doesn’t always have to be that way, either.

America’s real estate industry has been built on the foundation of the 30-year mortgage loan. These mortgages give the lending bank a position in the ownership of the property until the loan is paid off. Those banks make money off the interest paid long term, so stretching out the payments across decades is good for their business.

In a Land Contract or Seller-Financed Mortgage Contract, the Seller takes the place of the bank and retains an interest in the property until the purchase price is paid off. But most Sellers are not in the business of making money on interest like a bank, so a shorter contract duration makes sense.

In fact, many Sellers want to cash out of their property as quickly as they can; they would take the immediate cash payment from a bank mortgage sale if they could, but agree to a Seller-Financed deal as a way to move a property that has sat empty for awhile.

Other Sellers may be dealing the property to a friend, family member or acquaintance, and Seller-Financing makes it easier on the Buyer versus pushing him to a bank with all of its paperwork requirements and fees.

And of course, other Sellers do sell property via Seller-Financing to bolster the total net dollars earned, collecting interest on the payments for as long as possible and getting a premium asking price for doing so.

For those going the Seller-Financing route as an alternative way to sell a property, many times the contract duration is set only long enough for the Buyer to find bank financing. That structure allows the Seller to cash-out on the deal after collecting monthly payments for a short time period while giving the sale the best chance of being successful.

Typical timelines are three to five years. The balance due at the end of that time period is called a buyout amount or balloon payment.

Buyout timelines should be set with consideration given to state law, too. In some states, if a Buyer fails to make payments and breaches the contract before 60 months, a simple eviction process is undertaken to remove the Buyer and reclaim the property. But after 60 months, a foreclosure must be undertaken. Setting the buyout period to fall just before month 60 eliminates the possibility of a protracted foreclosure process.

But in the end, the duration of the contract, the purchase price of the property, the interest rate charged, and other terms and conditions are completely negotiable between the Buyer and Seller — and both parties should remember this important fact.