In today’s blog, we will be answering a common question asked by individuals interested in commercial real estate investing, “What is a balloon loan?” and diving into the basics of this fun term. Let’s jump in!
What Is A Balloon Loan?
First and foremost, a balloon loan is a loan that does not fully amortize over its term. Thus, at the end of your term, you will have to pay the remaining principal balance of the loan, called a balloon payment. OK — it’s not as fun as it sounds.
Why Take Out A Balloon Loan for Commercial Real Estate?
Taking out a balloon loan for commercial real estate is beneficial because it doesn’t lock real estate investors into a set rate for a prolonged time. Balloon loans allow commercial borrowers to refinance their loan when it’s time to make their balloon loan payment — about every five to seven years. Refinancing allows investors to start fresh with a new loan, longer repayment period, and possibly a lower long-term interest rate, improving cash flow.
Favorable Rates & Lower Loan-to-Value Terms
Many lenders offer more favorable rates and lower loan-to-value terms to real estate investors, which makes taking out a balloon loan appealing.
How Do Commercial Real Estate Balloon Loans Work?
A commercial real estate balloon loan works similarly to traditional commercial mortgage loans, but differs in terms of repayment. A traditional commercial mortgage loan has an average term of five to twenty years with an amortization period that’s longer than the term of the loan as a whole. The average term of a balloon loan is five to seven years with a separate amortization period of twenty five years. In this case, with a balloon loan, the investor would pay the loan for the balloon loan term based on the 25-year amortization period and at the end of the five-to-seven year term, they would have to pay the remaining balance of the loan in one full payment.
What Are My Options When the Balloon Loan Is Due?
As mentioned above, one option is to refinance your balloon loan when it’s time to make your balloon payment. Refinancing when a balloon payment is due is a common practice for real estate investors because it allows commercial borrowers to start fresh with a new loan and better rates.
If your commercial property is worth more than you owe, another option is to sell your property to pay off the balance of your balloon loan.
If you have the cash flow, paying off your balloon loan is ideal. Unfortunately, this is largely not the case for most commercial real estate investors, as the balloon payment is often a hefty price to pay.
What Are My Risks?
Be warned — balloon loans are risky. Commercial borrowers are not guaranteed to be approved for refinancing and property values are always changing. Thus, there is the risk that if you cannot refinance, you will default on your loan and your property could lose its value, making it impossible to sell for profit. With all loans, it’s best to speak to a loan specialists to discuss your needs and get professional advice on the best type of loan for you and your circumstances.
Contact a trusted, passionate, and dedicated loan specialist today at Abbey Mortgage & Investments, Inc. to see if a balloon loan is the best type of loan for your commercial real estate investing needs. We look forward to speaking with you and assisting you in your endeavor.