It is time to dispel another myth about balloon notes. A guru is trying to sell his/her get rich quick program by telling new investors they will get more money for their property by offering the buyer low interest owner financing, in order to make the payments exciting. The guru then instructs the investor to combine the low interest rate note with a "short fuse" balloon. Now the guru says to wait for some seasoning and then sell the note. According to the guru you will get "top dollar" for your note by following this illusional procedure

I want to emphasize this balloon note myth because in the past month, I have been contacted by three note sellers who have sold their property with a 5 year or less balloon, and insisting their note is more valuable because the Note Buyer will be getting his/her note investment back in a short period of time .

One note seller who contacted me only yesterday even had his calculator out, telling me exactly how much his note was worth according to this guru's teachings. His arguments were valid if, and only if, you assume the balloon is actually going to be paid off when the balloon becomes due. It took me a while, but I finally convinced the note seller the error of his reasoning.

Let's look at an example. Not only will you get a chance for a little calculator practice, you will also learn HOW "short fuse" balloons are perceived by Note Buyers in the real world.

I am going to address only the "crunching of numbers" for balloons, and assume the property has equity, and the payor has acceptable credit. Let's also assume the seller has $100,000 note @ 7%, amortized over 30 years, with payments of $665.30, with a 5 year call/balloon. The note seller comes to me exactly one year after the note was created and wants to sell his note. Here is what the note looks like.

N = 48
I/Yr = 7
PV = $98,984.21
PMT = $665.30
FV = $94,131.76

The note seller insists that if I buy this note and want to achieve a 10% yield, his note is worth $89,434.72. (Simply substitute 10% yield for the 7% and solve for PV) This is where the guru's "teachings" do not reach from the podium to the pavement. While his math is correct, the note seller errs in thinking yields are determined when notes are created or bought. NOT TRUE. Yields are realized when notes are liquidated, not when they are created or bought. This concept cannot be stressed enough.

I ask the note seller, "What happens if the payor cannot refinance when the note is due in 4 years? Do you really think the payor will be able to refinance in 48 months"?

"No not really, but no problem", exclaims the note seller. "You merely extend the note". (of course 'no problem' for this note seller, he has his money. But for me, the Note Buyer, extending a note presents another set of issues, but for now I am addressing only the math.)

"Great!", I say. "We are on the same page. And how many times will I have to extend this note"?

"As long as it takes", snaps the note seller.

"We are still on the same page", I calmly replied to the note seller.

As a Note Buyer, I will have to assume a note with a "short fuse" will have to be self liquidating, meaning the note will have to be extended until the balance is paid off. Since he had his calculator in front of him, I asked the note seller to use his own assumptions, that the note will have to be extended indefinitely, and for me to achieve a 10% yield.

"Enter these figures into your calculator, and I will abide by its findings. Fair enough"? I asked.
The note seller then entered 348 into N (number of months left on the 30 year amortization) 10% into I/YR, PMT remained at $630.30, with 0 in FV. Now solve for PV.

Next I heard only silence. I knew the figure he was looking at was $75,390.06. Reality was beginning to set in.

"I was not expecting this much of a discount," pleaded the note seller.

"How much money do you NEED", I asked.


"$25,000", the note seller quickly replied.

"I can get you very close to your goal. I can offer $23,965 for the right to receive the next 47 payments. You can then keep the last payment, and the balloon". ( There is a reason I did not buy the full 48 payments before the balloon. This is another topic) "If your payor can refinance, then you come out way ahead. If your payor cannot refinance , you can extend the note, but call me first. I will help you structure your note to give you maximum value".

"I'll get back to you", sighs the note seller.

He did say he had similar offers for the entire note, and mine was higher. The difference was I took the time to explain "why" all the offers for the entire note were lower than expected. Why was the note worth only $75,390.06? Because the note had a below market interest rate, and did not take into consideration that Note Buyers would consider a short term balloon to be a self liquidating note.

The moral to this story is that notes with short term balloons, will not be priced strictly according to yield , but rather by the reality of the payor being able to refinance. In today's market the chance of this happening is next to nil. The Note Buyer has to assume the payor will not be able to refinance. Therefore short term balloons are bought either one of two ways.
1. Assume the note is self liquidating
2. Buy the payments only, and let the note seller keep the balloon.

More importantly, DO NOT BELIEVE GURUS selling get rich quick programs.

The NOTE PROFESSOR NOTEBOOK has 3 time proven techniques to bust balloons.

If you are selling your property using owner financing, please contact me. I will help you structure your note to give it maximum value in today's market.

If you have a question on your note or a Note to convert to cash, contact me
I will be happy to discuss your specifics.


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All rights reserved

Would you like to learn the hands on mechanics of how to broker notes? Bring a note to "co-broker" and as soon as the note is closed we will split the profits. Also I pay a referral fee for notes that are referred to me.

Tom will be speaking again at this year's NoteWorthy Convention held in Las Vegas on October 2nd through Ocober 5th. Tom's topic "How to Obtain Obscene Yields with Small Money", are excerpts from THE NOTE PROFESSOR NOTEBOOK. Email Linda for details: linda@noteworthyusa.com. Hurry to take advantage of the discount, which ends July 31st.

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One 100th of 1%. Often denoted as bps. For example, interest rates rose from from 6% to 6.5%. There was a rise of 50 basis points.

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By keeping interest rates artificially low the Federal Reserve has painted itself into a corner. It cannot keep creating money out of thin air, which is the definition of inflation, and keep interest rates this low indefinitely. When the Federal Reserve does decide to raise interest rates, this is going to make your note become less valuable, because Note Buyers will also demand higher yields to cover the cost of their funds.

What should you do?

1. If you have a note you need to sell, SELL IT NOW. It will only lose value if interest rates rise. If you were offered only 65% for your entire note because of no equity, or low credit of your payors, do not wait to sell, thinking Note Buyers are going to pay more in the future. It is not going to happen. If fact, if you fall into this category, you might want to weigh the risk of having to foreclose in a down market, as opposed to cashing out now.
2. If you have a good note, where there is large equity, with good credit for the payor, you might want to consider cashing out to give you security of being liquid, or to make other investments.
3. If you do have a good note, you can just keep it, and be satisfied that you are receiving a relatively safe monthly income.

These are subjective decisions. One thing is for certain, the artificial low interest rates, along with the Federal Reserve and Treasury Dept borrowing or printing money to bail out everybody from Bear Stearns to Fannie Mae is inflationary. This means higher interest rates are in the future, making your note less valuable. Plan for it.

Copyright © H&P Capital Investments LLC
All rights reserved .