Most investors of commercial real estate secure a loan, or mortgage, to cover a portion of the purchase price. Unlike a residential mortgage, which typically carries a fixed rate term of 30 years, commercial loans are often 5 to 7 years in length and include a balloon payment at the end of the term.
It’s very important to understand how balloon payments work and how they can affect your overall investment strategy. Here are a few basics that can help you when it comes time to decide what type of loan best fits your specific needs.
What is a Balloon Payment?
Simply put, a balloon payment is a lump sum that is paid to the lender at the end of a loan’s term. It is generally quite a bit larger than the other monthly payments that a borrower has made throughout the loan. The idea is to set smaller monthly payments over a shorter term, and then to make one large payment at the end to satisfy the loan — hence, the balloon payment.
This strategy is often used to help borrowers keep their payments down, but it’s vital the borrower keep track of the payment date and terms.
This scenario is most useful for borrowers who are financially stable and have strong and predictable future income. Borrowers with these characteristics are less likely to get caught off guard when the payment comes due.
Options When a Balloon Payment is Due
Here are some of the most common options available to borrowers when they’ve reached the end of their loan’s term:
One option to pay it off is to refinance the loan. The new loan would extend your repayment period (you’d essentially start over with a 5-7-year term) and allow you to pay off the balloon payment. In order to do this, you’d need to qualify for a new loan — so your credit, income, and assets need to be in good shape.
#2. Sell the Asset
Another option is to sell the real estate and use the proceeds to make the payment. This strategy assumes that the market is in good shape and that your property has maintained (or appreciated) in value.
#3. Make the Payment
If cash flow isn’t a problem, there’s always the strategy to simply pay off the balloon payment when it comes due. If this isn’t feasible, then you may need to default to one of the first two options.
Refinancing Before a Balloon Payment
If you’re considering refinancing your loan before a balloon payment comes due, our team of knowledgeable funding experts at Commercial Direct can help you navigate your options. Learn more by connecting with our team today!