A balloon payment is a lump sum payment that is significantly larger than the monthly payments and paid at the end of a loan’s term. Unlike loans that have a series of fixed payments to pay off the balance of the loan, a loan that includes a balloon payment is made up of lower fixed payments and a final larger payment.
Although loans with balloon payments can be right for some borrowers, they are one of the riskier types of loans available. Before you seek out this option, read on to learn more about balloon payments, their benefits and downsides, and when—and when not—to use them.
What is the role of balloon payments for businesses?
Borrowers can expect a balloon payment to be many times the amount of the previous payments - sometime even hundreds of times greater. These loans tend to have shorter terms than traditional loans, with the final payment due after a few months or years.
Although the structure of the loan can be suitable for some businesses, balloon loans are riskier because of the final payment. To avoid potential defaults, most lenders will provide these loans to businesses and consumers that have excellent credit, sufficient savings, and stable incomes.
What are 4 things borrowers need to know about balloon loan payments?
Because loans with balloon payments can be risky for some businesses, it’s important to understand the characteristics of the loan to decide if it’s the right choice for you.
1. Lenders might not refinance your balloon loan.
For business owners who pay only the minimum payment on their balloon loan until the final payment is due, there is a possibility that they will have negative equity. With negative equity, banks are not likely to refinance the balloon loan unless the borrower can come up with the down payment. If the borrower cannot refinance the balloon loan or pay the full balloon payment, they risk defaulting on the loan.
2. Balloon loans are riskier for commercial real estate investment.
Because of the payment schedule, these loans can be riskier for investors or businesses that want to purchase a piece of property. With a relatively short term for the loan, balloons should not be used for long-term investments. An amortizing loan over 15-25 years might be a better option for commercial real estate investment.
3. The price of the loan might be higher in the long run.
The overall cost of the loan can end up costing the borrower more in the end compared to a traditional loan due to closing costs and fees, which the will borrow incur each time the balloon loan is refinanced.
4. The burden at the end can be great.
For business owners who miscalculate or don’t meet their expected income forecast, the final payment can end up being a major issue, not only in the present but in future borrowing opportunities as well.
Can a borrower get out of a balloon loan payment?
If you have taken out a balloon loan and are finding yourself stressed or unable to pay the final payment, you can consider refinancing. You have several refinancing options:
- SBA 504 loan - These loans are used specifically to fund business growth and job creation. Keep in mind, however, that the SBA doesn’t always allow refinances. If you are eligible, a 504 loan can minimize the risk associated with the balloon payment and let you enjoy longer loan terms and pay back the loan with a low fixed interest rate. Refinancing with a 504 loan can save you money and help settle any anxiety that you have about that final balloon payment.
- Adjustable rate mortgage (ARM) - These loans have an adjustable rate and are amortized over 15-25 years. If you think you might need to refinance a balloon loan, this is significantly less work, since you will need to “touch” your loan each time the balloon terms. Not to mention the additional closing cost each time you refinance the loan. With an ARM, the rate adjusts periodically based on market conditions. These are also a good first option to finance commercial real estate and commercial investment properties.
Make smart financial decisions with Crews.
As a fourth-generation family-led bank, Crews is dedicated to helping individuals, families, and businesses make the best financial decisions for their situations. We offer guidance and loans that fit your specific needs so that you can thrive as individuals and members of our community.
Interested in learning about how to finance your next business endeavor? Give us a call and we would be happy to help.