What is a Balloon Payment?
A Balloon Payment is a large one-time payment at the end of the loan term. In a Balloon Payment Mortgage, also known as Balloon Loan, borrowers make relatively small monthly payments compared to a traditional loan and usually covers the monthly interest only.
In general, balloon loans have shorter terms, ranging from five (5) to seven (7) years in duration than traditional installment loans. It allows borrowers to have access to lower monthly loan repayments in the initial stages of the term. However, these payments are not sufficient to pay off the remaining loan balance before it comes due resulting in an inflated size of the final payment. Hence, the term “balloon” because of its significant lump sum payment at the end of the loan term.
Despite having low initial payments, balloon loans pose a high risk compared to traditional installment loans because of the large payment due at the end of the term. Thus, balloon loans are usually restricted to creditworthy consumers and businesses that have stable income streams. Many sellers will provide, what’s called a seller carry loan, using a balloon payment to attract buyers who can’t qualify for a traditional loan. This provides more opportunities to find a buyer for their project.
Pros and Cons of a Balloon Payment
In certain instances, balloon loans are a good choice to consider when making financial planning and management. Though it comes with advantages, it has certain downsides too. Here are some of the pros and cons of loans with a balloon payment:
- Low monthly payments
- Balloon loans can be an advantage to a start-up company that is looking to have lower monthly payments during its early phases; or to consumers and businesses who wish to develop an investment that requires little to no initial payment until it yields cash flow at a later time.
- Short-term mortgage
- Balloon loan can be a good choice to consider for investors who aim to free up capital by minimizing short-term loan costs.
- A great tool to help cover financing gaps
- Borrowers can take advantage of balloon loans when they are experiencing immediate financing needs but are also foreseeing a good income in the future. This could reduce the financial burden of the business in the development stages until it prospers.
- Higher loan cost in the long term
- Since balloon loans have lower monthly payments than traditional installment loans, the total cost of the loan can be higher especially if monthly payments are interest-only.
- Risk of losing the property
- Given the fact that a balloon payment requires a large lump sum payment at the end, and if for any reason the buyer is unable to make the balloon payment, the seller can take back the property and keep the deposit. This poses a great risk for a buyer who does not have the financial capabilities to produce this significant payment due at the end.
- Difficult to refinance
- Refinancing often requires a minimum amount of equity and typically, balloon mortgage payments have interest-only monthly payments. Because the principal balance or equity of the property is not being paid, it makes it difficult to refinance balloon loans.
Even after outlining all the information above, investing in CRE can still seem daunting. That’s why the Leveraged CRE Investment Team at Commercial Properties, Inc. is here to help you achieve your investment goals. Contact us at (480) 330-8897 or send us an email at email@example.com.
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Phill Tomlinson is a commercial real estate broker with Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, and owner of the Leveraged CRE Investment Team specializing in investment sales and tenant/landlord representation in the Phoenix and Scottsdale submarkets. Phill applies over 21 years of experience in the Real Estate industry helping investors and owners maximize their returns.
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