Epic Real Estate Investing - The Wonderful World of Balloon Payments: Creative Real Estate Investing Continued... | Episode 204

Episode Date: May 9, 2016

Scoring a property with a balloon payment in the terms can send a shiver down even the most experienced investor’s spine.  The thought of being financially liable for a large cash payment in the future (which you are likely unable to afford today) is a scary thought.  Where will you find the money?  And worse – what if you can’t? The truth is that balloon payments are a valuable tool in the creative investor’s toolbox. They aren’t nearly as scary as they seem, and combined with a strong portfolio, allow you to grow your cash flow quickly and safely!  Today Matt tackles this issue and puts your mind at ease so that you can open yourself up to the wonderful world of balloon payments.  Enjoy!  ------- The free course is new and improved!  To access to the two fastest and easiest strategies to a paycheck in real estate, go to FreeRealEstateInvestingCourse.com or text “FreeCourse” to 55678. What interests you most? E.ducation P.roperties I.ncome C.oaching Learn more about your ad choices. Visit megaphone.fm/adchoices

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Real estate investments involve a high degree of risk. Residential income and returns may vary and are not guaranteed. Past performance is no indication of future performance. Nothing herein shall be construed as investment, tax, legal, or accounting advice. This is Terio Media. Broadcasting from Terrio Studios in Glendale, California, it's time for Epic Real Estate Investing with Matt Terio. Welcome, welcome to Epic Real Estate Investing,

the place where I show people how to escape the rat race using real estate. Just shift your focus from making piles of money to making streams of money. Change that one thing just one time, and you are on your way to financial freedom. It's not the most exciting path. It's rather dull and boring. But it is the fastest. And once you get their life, then becomes exciting.

And speaking of exciting, this little series we got running on creative real estate investing seems to be very exciting for people as I'm getting a ton of feedback and a ton of inquiries. So a lot of great feedback from last week's episode specifically on seller financing. And it was really nice to witness firsthand all of your wheels turning, all of your wheels spinning. And if you missed the last episode, per the audience, it's an episode you're going to want to probably go back and listen to.

And one thing that came up, and I'm not surprised, but one thing that came up that many of you just can't seem to get past is the balloon payment and how to manage that balloon payment. It's a source of fear for a lot of people. They think they're going to have to make this giant payment somewhere down the road and they don't know how, have any idea how they're going to do it. So I was going to cover this topic in a few weeks, but since it was at the top of conversation after, you know, it is the top of conversation this week after last week's episode. I'm just going to bump it up in the schedule and we'll discuss it now. All right? So to clarify and just be certain that we're all starting on the same page, a balloon payment is pretty much what you might guess it to be.

It's a large payment that it's a payment that balloons and they can be a really valuable variable to play with when negotiating seller financing. But a lot of people are afraid to use it because they don't know how they're going to pay it back at some point. I mean, for example, let's just kind of create the scenario. If a seller wants $100,000 for their property and you've determined it's not actually worth much more than that. So let's just say fair market value is $100,000 and the seller wants $100,000.

You can still make this a deal for yourself as long as you can control the terms, the terms and how the $100,000 is going to be paid back to the seller or paid to the seller. So remember, we purchased property in one of two ways, right? Let's cover this. We purchase property in one of two ways, either by your price in the seller's terms or the seller's price in your terms. one of two ways. You've got to control the price or you got to control the terms.

As long as you control one, you can create a deal for yourself. So since the seller is stuck on their price of $100,000 for their $100,000 property, you must take control of the terms because, you know, paying retail for that deal that doesn't make it a deal, right? So if it's worth $100,000 and they want $100, then how do you do it? You take control of the terms. That's how you make a deal for yourself. So we'll keep our example from last week, being that this particular property is going

to rent for $1,200 per month. And after all the property's expenses are taken care of, we're left with $720 per month of income before debt service, okay? So just $720 per month that the property is going to generate that you get to put in your pocket before debt service. So if the seller is going to carry back the $100,000, we need to focus on structuring some sort of terms that costs less than $720 per month.

Probably right around $500, I would say, would be the max we'd want to pay. That'd give us a couple hundred bucks, per month of cash flow. Okay, so that'd make it a decent deal. So let's say we offer the seller, we'll just go with $500. I'll pay you $500 per month until the $100,000 is paid off. Say that was your offer.

Those are your terms. That's your offer. Now, the seller comes back with, I'm okay with the $500 per month, but I'm not okay with the 16 plus years that it's going to take to pay it off. So you propose, well, what would you be okay with? And say they said half that. How about eight years? all right so okay we'll do eight years and then we'll give you the balance a balloon payment on day

one of the ninth year that payment of that balance that's what's called the balloon payment so you're going to pay $500 per month for eight years that would equal right around $50,000 I think is what it comes out to give or take um so you still have half of that to pay right you have 50,000 bucks to pay off and that's your balloon payment so now we've got our scenario in place and the common question here is what are you going to do in eight years when you owe that $50,000 on the property? Where are you going to get the $50,000? See, that's the big fear, the big fear of coming up with a check for $50,000. All right. So let's work through this. First of all, when that day comes and you don't have the money, let's just say you don't have the money to pay it off when that day comes. You could walk away.

You could just walk away. I mean, just default on the property. Give it back to the same. seller and walk. In most cases, it would be a non-recourse loan. So walk. If you did your paperwork right, it's a non-recourse loan. So just walk. You could do that. Now, I'm not saying to do this.

No. In fact, I'm saying don't do this. But I bring it up just to point out that you're not going to die. You're not going to jail. And if you drew up your paperwork correctly, it won't even impact your credit score. nothing is going to happen to you if you walk. It's a really crappy thing to do for sure. And I'd suggest you absolutely do not do this.

It's not good for future business. But if you did, nothing is going to happen to you. The point being, don't be afraid of balloon payments. Don't be scared. There's nothing to be scared of other than there would be a person walking the earth thinking you're a total douchebag, right? That would be the worst thing that would really happen. So I just want to point that out the worst case scenario.

And it's nothing to really fear not to get in the way of your wealth building. And that's for sure. Now, speaking of someone walking the earth, not thinking that much of you, that actually might not even be the case. In fact, the seller might even be better off for you walking away. Here's what I mean. If that seller collected eight years of payments from you and they got their property back and now they get to sell it all over again.

In this event, after all is said and done, the seller will probably make money because you walked away than if you hadn't. I mean, why do you think banks lend money to buy real estate? Because in most cases, I mean, it's, in most cases, they'll collect a 20% down payment, right? That's just a customary amount, 20% down payment. And then the property has to appraise

so they don't want you to overpay for the property because they don't want to be upside down on the property, so that's why they're collecting the 20% down payments, so they have a 20% equity position. Then the monthly payments, you'll pay those for a number of years. And should the borrower default, the bank forecloses. And they sell the property all over again,

taking in another 20% down payment. And then the monthly payments start all over again. And likely the property is probably worth more than it was when they gave the loan on it originally. And they get to keep all of that new. equity as well. That's why banks are in their business, because customarily what goes bad with real estate turns out to be more money for them. So should you walk away from the seller, even if they're upset about it, you're not leaving them high and dry in a bad situation. Okay, they still

have the property. They can still resell it. They're still going to profit. And most likely, who depend on, you know, how good you were making your payments and how long you made those payments for, but most likely they're going to make even more money than, if you had followed through with the actual terms of the deal. All right. So I'm going to repeat. Don't do this. Okay?

It's not good business. It's not even business, really. It's just being a jerk. But again, I just want you to keep all that in perspective that there's nothing to be scared of. You're not going to jail. You're not going to die. And it's unlikely it would even hit your credit score.

All right? So now that we have that established, let's move on to what there really is to do. I just want to put it all in perspective for you that there's nothing to be afraid of. So as far as the worst thing. the case scenario. All right. So the most important thing here is make sure it actually works out to be a cash flowing deal for you.

Okay. Don't take on a balloon payment deal just because I told you to, just for the sake of it, just because the seller agreed to it. I get a lot of inquiries. Hey, the seller agreed to my terms and I look at it's like, well, these are terrible terms. That's not a deal. So it still must be a deal.

Okay. Don't disregard your normal property analysis. So that's the foundation for moving forward, making sure that it does fit your minimum deal standards and that in understanding that there's nothing to be afraid of by using a balloon payment as a negotiating tool. All right. So now that that's out of the way, here's where I see most people get stuck. Let's say that this, they get this deal under contract.

They're paying $500 per month. And all they can think about is having to write this big check in eight years when the balloon is due. So let's look at this. What are your options? What are your options for this property and this balloon payment? Okay, you could walk away, like we said, but don't do that, all right, but that is an option. So there's one. Two, you could refinance the property with more conventional terms.

You could get a longer term note on it, and you got eight years to figure that out on how to do that. And that could be through a, you know, a traditional financial institution, like a bank, or it could be Uncle Ray Ray. It could be a private loan. All right. So you could refinance the property. So, and you got eight years to figure out how to do that. That's a long time.

All right? Number three, you could sell the property, right? After all, you've paid down the note for eight years in this scenario. And likely you experienced a little bit of appreciation along the way as well. There's probably a good chunk of equity in the property and a quick sale to bail you out of the long, or that loan, those loan terms. That would probably pretty pretty easy. And you probably put a big chunk of money in your pocket. So you could sell the property.

You could refinance. You could sell the property. or you could resell the property or could sell the property. Or here's another one that most people don't think. You could renegotiate the terms with the seller. You could ask for an extension of payments. Or you could negotiate the balloon payment. Maybe the seller, knowing that you can't make the entire balloon payment,

would rather take a discounted payoff instead of taking the property back and selling it all over again. Maybe they don't want to go through that hassle. So they might negotiate a discounted payoff. So the point here is with this one property, just the one property, you have options. And the worst case scenario is not going to kill you and it's not going to send you to jail. Now, after hearing all this, if you're still a little nervous about the idea, here's where the possibilities really open up. Stop looking at these balloon payments as individual entities. And look at your portfolio as a whole.

I mean, is this the only property you're going to purchase between now and when that balloon payment is due? I mean, are you just buying the one property and you're done? And you're not going to do anything until you get this one resolved? I hope not. No, you're going to keep your investing going. And with the more deals you have in your portfolio, the more options you will have to manage this. And all of your balloon payments. I mean, if your portfolio consisted of entirely properties,

that had balloon payments on it, the more properties you have in that portfolio, the more options you're going to have to manage this. Understand this. It's much easier to manage the debt on your portfolio than it is to find new deals to put into your portfolio. So the more properties you have in there, the easier to run your business and the easier to create your wealth and build your wealth that's going to be. And here's some examples.

Let's say you have 10 properties in your portfolio and a balloon payment is coming due. a balloon payment on one of those properties come to do. Now, you have nine other properties to look at as a possible solution for your balloon payment. We talked about you could refinance. That could be through traditional lending sources. It could be from a relative or a friend. It could be a private loan. You could sell one of those properties, maybe the one you don't like so much,

take the cash there and pay off the balloon payment. You don't have to sell the one that the balloon payment is due on. You could sell another one that you might have equity, maybe one that's giving you some problems or one that you're ready to try. trade up? And what if you had 20 properties in your portfolio? Wouldn't you have even more opportunity to manage this balloon payment? Indeed. I'm telling you, though, the bigger your portfolio becomes, the easier this is going to be, and it'll get to a point where it's not even concerned. You just be taking control of deal after deal after deal using these balloon payments as

part of one of your negotiating tools. Here's something I do. Okay? Here's something I do. from the moment that I take ownership of a property, one that I've acquired with a balloon payment, or one that I've acquired with seller financing in any respect, I'll schedule in my calendar every six months to offer a discounted payoff of the loan, meaning every six months I will call that seller. It worked like this.

Hey, Mr. Seller, I've been paying you $500 a month for the last six months. And I was wondering if you could use a nice big payment and we could clear this all up. As I have it figured out right now, I owe you $97,000 still on the property and I could continue to pay you $500 per month for the next seven and a half years, or I could write you a check today.

I could have this by the end of the month for $75,000. Would you be open to something like that? See? See how I said that? I could write you $500 per month for the next seven and a half years. Or we could just settle this once and for all for $75,000. Now, if the seller said yes,

that one question just made me $22,000. I owed $97,000 on it, and I offered a payoff of $75. That saved me $22,000 right there. Now, if the seller said no, then I'd say, okay, just thought I'd ask. Just because you ask, they can't take the property back from you. See, what's wrong with asking? Okay, just thought I'd ask, and then I'd call them again in six months and have that same conversation.

And I'd do it every six months. I do do it every six months until they do agree to some sort of discount of pay. payment. And I got to tell you, they will agree to it at some point because their life changes for everybody. And there's a lot of things that change in people's lives that money can solve. And $500 a month for most people isn't really impacting their life. In some cases, it might even be a little bit of an inconvenience or a nuisance that they even have to watch it and try to remember to collect it. Right. So a discounted chunk payment and is going to be a viable solution at some point most likely. And so just keep that in mind. So I try to take care of this loan

every six months, way before the balloon payment is ever due. The other, this is what I lost my train of thought there for a second. You could probably tell. What I was going to say was, the further you get out from that transaction, the lower the emotional attachment becomes, the less powerful that that becomes. And all of a sudden, we're just talking dollars. Like, I'm getting these $500 a month. for the last two years, yeah, I'll take 50 grand. So that emotional attachment, it kind of dissipates. And so the longer you're paying that loan, typically the lower that barrier of negotiating becomes or that lower, that barrier of resistance in negotiating a discount becomes for the seller.

All right. So I do that every six months way before the balloon payment is ever due. So that's another way of getting rid of the balloon payment. Don't wait to do it. Take a stab at it every six months to, to, to, negotiate that. All right? So now you're wondering, what if I don't have $75,000 to pay it off, right? Okay. You guys, you got to stop looking at things, looking at for reasons why this won't work. You have to start looking for reasons why it will work and how it will work. Right. So, well,

let's say we don't have $75,000. Well, don't offer $75,000 if you don't have it. Offer $60,000 or offer $50,000. The seller can't take the property back from you just for asking. Okay. But what if you don't even have $50,000? Okay. Okay, great, great, no problem. That's what the rest of your portfolio is for, to start moving debt around from property to property so you can clear one of your dud houses and sell it, take the profits from there and pay off the discounted offer,

pay off the nicer house that you want to hold on to. All right, so how do you do that? Well, this is called substitution of collateral. And it's a way that you can do your own cash out refinances in the event that a bank won't approve it. And if, say, Aunt Millie is tapped out, you can do you can do uh you substitute the collateral around you can move the debt around it works like this within your seller finance paperwork you include a substitution of collateral clause and you

technically don't even need this because you i'll explain in a sec but it's it's a substitution of collateral clause and what this allows you to do is to take the debt off of one property and move it to another freeing up that that original property so in this example when when you place that call to the cell you had a $97,000 loan to still pay off, and the seller agreed to, and say that the seller agreed to your $75,000 discounted payoff. So you look at the rest of your portfolio. And say you have a property over here with $100,000 of equity. It could be any property. It could be a single family, a fourplex, it could be a multifamily building. So you have a property with $100,000 of equity. And you have a second property valued at $100,000 with a $75,000 mortgage. And this is the one

that you might not want to hold on to. So per year, you know, your substitution of collateral clause, you could move the $75,000 mortgage over to your property that has the $100,000 of equity, leaving you with the property that's free and clear, valued at $100,000. This one that you don't really care too much about. Maybe the one that you want to remove and kind of upgrade that property. So you could take the $75,000 mortgage on it, so this property only have $25,000 of equity on it. So you can't sell it and solve your situation. But if you take the debt on that property, move it over to where there's, you're, you're,

is room on another property. Now you have $100,000 property paid off free and clear. Now you sell it and then you pay off the discounted price that you negotiated with the seller of that original property and then you put $25 grand in your pocket. And now you've realized your $22,000 profit from that original request of the discounted and payoff. Did you follow along with that? I know it's kind of hard maybe to follow along with audio.

It couldn't be somewhat of a visual thing. But what you're doing is just taking the debt from one property moving on to another and that frees up all of the equity on that one property where you've removed the debt from. Now you can sell that property, collect 100% of those proceeds, and then go pay off the balloon payment that you just negotiated. So that's called substitution of collateral, and you want that clause inside of your contract. But even if you don't have it, say you've got some properties right now that have balloon payments on you're like, oh, shoot, I never put the substitution of collateral on there.

This is how you do it. You just call up the seller of the property where you want to move the debt and say, hey, I'm upgrading my portfolio. Would you like me to take your debt over to the new part of my portfolio? It's higher quality. It's a better position. I'm holding on to it. This is the property I really want to keep.

It's just going to secure your payments into the future. No people are ever going to say no to that. I'm going to take you to a better property. I'm going to put your debt on a better property than the one that I purchased from you. Would you like to go with me? Nobody ever says no to that. Okay, so you don't even need the substitution of collateral clause. It's just a phone call to the seller.

and they'll typically always say yes to that. Right? And so now you move that debt to this other property and now you got this one that's owned free and clear and you can sell it and do whatever you want with that. Okay? So sounds great, right? But what if you don't have a portfolio to do this with?

Exactly. That's why you keep buying. You don't let these balloon payments get in the way of you progressing forward from building your portfolio. You don't buy one property. Get seller financing what the balloon payment do in eight years and do nothing between now and when that payment is due. No, you continue to do deals,

and you're going to continue to score base hits, just like you did with this property, and you're going to score some home runs along the way as well. Keep your business flowing, because the more you do, the more options you create for yourself. Balloon payments, they're a wonderful thing, is they are a negotiating tool

that enables you to buy and control more property, much more property than you would have been able to do or to buy if you had not used the balloon payments as a negotiating tool. You know, back on episode 106, quite a while ago, I discussed a lot more about balloon payments and how you can really accelerate your wealth by collecting deals with balloon payments. And if you're intrigued by this and you're getting it, it's starting to click. I talked a lot more about it.

And if you want to learn more, go back and download episode 106. I think it's called How to Get Wealthy with balloon payments. Because there's a lot more to it. And it's all good stuff, by the way. It's very much part of your intellectual currency. It's part of that creative real estate investing. So go check out episode 106. And how did you do with your homework?

How'd that go? Did you do it from last episode? Remember? It was to write $100,000 at the top of a piece of paper and come up with at least 10 ways to pay off $100,000. How you can structure terms for $100,000. And use balloon payments in your solutions. So here's another example.

What if you use two? balloon payments or more to just to get the deal closed. For example, let's go back to this deal. If you wanted to cash flow a little bit more than the $500 payment would allow, so what if you offered, I'll pay you $300 a month for four years. I'll then pay you a balloon payment of $10,000 after four years. And then I'll resume the $300 a month, $300 a month for four more years. And then the balance in a second balloon payment after a total of a year.

of eight years, the balance, right? Yeah, but where am I going to get $10,000 in four years, right? Is that what you're thinking? Stop it. I just told you. It doesn't matter anyway. As you're continuing to build your portfolio, the term of that loan probably won't even reach four years.

You negotiate a discounted payoff. You refinance it. You sell it. You move some debt around. You can do all of this if this was your only investment property. And you can do so much more if you continue to do deals and build your portfolio. If putting those two balloon payments inside of those terms was the thing, was the thing that put the seller over the top and agreed to sell that property to you, then that's the point.

Get another deal done. Giving you more options in building your wealth. If waiting for your investments to grow feels like waiting for pink to drive, there's a powerful secret your financial planner doesn't want you to know. You can accelerate your investments growth by two, three, or even four times. That's bad news for Wall Street, but great news for you. We are cash flow savvy. And we'd like to offer you free information that will show you how to take control of your investments and double, triple, or even quadruple their returns.

And it's yours for free. For the secret your financial planner doesn't want you to know, go to cashflow savvy.com. That's cashflow savvy.com. I'll see you next week. I'm Matt Terrio, living the dream. You've been listening to Epic Real Estate Investing, the world's foremost authority on separating the facts from the BS in real estate investing education. If you enjoyed this show, please take it. a minute to visit iTunes and share your thoughts. Thanks for listening. We'll see you next time

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