How “Stepped Payments” Can Make Carryback Paper Safer

I had negotiated a price of $295,000 on 4+ acres of unimproved commercial land in southern California. The buyers were willing to pay $52,000 cash down and wanted the sellers to carry the $243,000 balance on a note secured by a first deed of trust with payments of $2,478.49 or more per month including 8.5% interest with the entire balance due and payable in ten years from close of escrow. This would have generated a balloon payment of $100,545 at the end of ten years. As institutional financing on unimproved land is difficult to obtain, a large balloon payment could put both the note holders and buyer at risk.

In this case we knew that the buyers owned several parcels of land (15 ac + ) adjacent to this 4 acre parcel and it appeared that the highest and best future use of the entire property would be some type of neighborhood shopping center. Development would be years away.

I represented 19 sellers involved in the ownership of the 4 acres. Many of them were in their 60s and 70s. Before our negotiations were concluded I recommended that we counter the fixed monthly payment the buyer had offered with a stepped payment counteroffer. The payment would be fixed for the first two years at $2,478.49 or more per month. Beginning the third year the payment would increase by 5% to $2,602.32 per month. Each year after the payment would increase 5% with the final balloon due at the end of ten years which would amount to $27,408.39.

The monthly payment adjustments would look like this.

1999 $2,478.49
2000 $2,478.49
2001 $2,602.32
2002 $2,732.44
2003 $2,869.06
2004 $3,012.51
2005 $3,163.14
2006 $3,321.29
2007 $3,487.36
2008 $3,661.73

Seller advantage: Beginning with the third year each of my sellers would have more dollars to spend, helping them to keep pace with inflation. The balloon payment due at the end of ten years would be considerably smaller than what the buyer had originally offered, reducing the sellers’ risk in carrying the financing. Protective equity was increasing at a faster rate than it would have using the level payment originally offered with a large balloon at the end.

Buyer advantage: Buyers had the benefits of seller financing on better terms and at less cost than they could have obtained from an institutional lender . They were building equity at a faster rate and would have a lower and much more manageable balloon payment due at the end of ten years.

P.S. We subsequently dropped the balloon and continued with stepped payments until paid.

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