Terminology Used in Real Estate Contracts

This figure usually is about 1 percent of the beginning balance. Here is an example: If the principal balance of your note is $50,000, and the interest rate is 9 percent amortized over fifteen years, then the monthly payment will be $507.13, which is roughly 1 percent of $50,000.

The monthly payment may or may not include funds to cover taxes and insurance. Regardless of whether the monthly payment includes the cost of tax and insurance, the balance owed should decrease with each payment.

Do not create a note that negatively amortizes. This occurs when the amount of each payment does not cover the interest accrued and the difference is added to the principal balance. The balance therefore increases rather than decreases. Creating such a note decreases its cash value dramatically. Such notes usually will need to be
restructured before an investor will purchase them.

Keeping track of monthly payments can be tiresome.

Payment Due Date

This is the date when the first payment is due. It is a negotiable variable, just like the purchase price. Also negotiable is a "grace period." You may charge the payer a late fee if the payment is not received on time or within the grace period. However, this charge must be included in your note for it to be legally binding.

Do not allow the payer to habitually make payments late. Insist on promptness. Late payments decrease the value of your note; they are an indication of the financial weakness of the payer. A hefty late charge is a good way to encourage promptness.

Balloon Payments and Their Hidden Benefits

A balloon payment refers to a large, final payment. Balloons usually have a due date five to ten years from the date of sale but are negotiable like other variables. You don't want to make the balloon too close to the date of sale, because most payers will not be able to refinance or come up with the required amount of money in such
a short period of time.

Balloon payment clauses may read as follows: "On the ____ day of ____, (year) the entire sum of principal and interest then owing shall become due and payable in full."

There can be a couple of "hidden" benefits to balloon payments. Should the owner be unable to make the balloon payment, you have the opportunity to refinance the lien. You may want to increase the interest rate or monthly payment, or both. Doing so usually increases your return on the investment. You are then able to set a new balloon payment date and avoid a messy foreclosure.

However, increasing your return on investment is not the only benefit to revising the term and/or interest rate.The market value of your note, should you ever need to sell all or part of it, has increased as well. This is a true "win-win" situation for both you and the property owner.

Since balloon payments abbreviate the amount of time it takes investors to recoup their investments, balloons tend to increase the value of a note. An exception to this is when balloons are structured poorly.

It is a good idea to notify the payer in writing six months before the balloon payment comes due and payable. This gives him or her enough time to refinance or make other arrangements.