My wife and I are buying a MN home for $127600. We plan to sell it to our son and his wife via Contract for Deed. They will put down $5000 so the balance is $122600. To make it comfortable for them we propose monthly payments of $500, interest rate 1% and balloon payment in 5 years.

Question: since today's market-rate 5yrARMs are running 2.75-3.5%, would we be running afoul of the “arms-length” principle? How much would we have to increase the rate to avoid complications?