Balloon loans: how commercial loans come due before they're paid off

Two numbers that home buyers never see

A typical home mortgage has one number: 30 years. You pay for 30 years and the loan is gone. Most commercial loans have two:

• Amortization period: the years the payment is figured over, as if you'd pay the loan off. Usually 20, 25 or 30.
• Loan term: the years until the lender wants the rest of its money back. Usually 5, 7 or 10.

When the term is shorter than the amortization, your payments only chip away at the balance. The amount still owed at the end of the term is due all at once. That lump sum is the balloon payment.

Balloon = loan balance left after the last payment of the term

A worked example

A $1,500,000 loan on a small retail strip at 7%, with a 25-year amortization and a 10-year term. The payment is figured exactly like a 25-year loan:

After ten years and about $1.27 million in payments, you still owe $1,179,501, or 79% of what you borrowed. That's normal: early payments on a long amortization are mostly interest. In year 1 only $22,947 of the $127,220 you pay goes to principal.

What changes the balloon

• A longer amortization lowers the payment but leaves a bigger balloon.
• Interest-only years ($8,750 a month here) pay nothing down, so the balloon grows, and the payment jumps when they end.
• A shorter term means a bigger balloon, sooner.

How investors pay the balloon

Almost nobody writes a check for a million dollars. Most owners refinance into a new loan or sell the property before the term ends. Both depend on things you can't control: interest rates and the property's value when the balloon is due. If rates have risen, the new loan may be smaller, because lenders size it on DSCR, LTV and debt yield. If values have fallen, you may need to bring cash. This is called refinance risk, and it's the main danger of a balloon loan.

To plan for it, run the balloon payment calculator, then check whether today's income would support a new loan of that size at a higher rate in the loan sizing calculator. If it only works at today's rate, keep reserves or pick a longer term.

Common mistakes

• Comparing payments only. A 30-year amortization looks cheaper each month but leaves you owing more at the end.
• Forgetting prepayment penalties. Many commercial loans charge a fee to pay off early (step-down percentages, yield maintenance or defeasance), which can make selling or refinancing before the balloon expensive.
• Waiting until the last year. Start talking to lenders 12–18 months before the balloon is due.