It’s not that scary…
Most novice property investors tend to be unprepared for the concept
of living with a balloon mortgage. If you’re going to invest in commercial real estate, a balloon payment mortgage will be a given. And in most residential real estate deals where the owner is offering a mortgage, you can also expect a mortgage balloon payment as well. So, what is a balloon mortgage you might ask? The simple answer is that, at the end of the mortgage term, you will still owe a large chunk of the principal on the property you purchased. The balloon mortgage definition is that the balance will need to be paid, on time, at the end of the term in the form of a large, “balloon” payment for this balance due.

Balloon mortgage definition example
To help define balloon mortgage more concretely, let’s look at an example. Let’s say you purchase a property for $100,000. The seller will give you a first mortgage for 75%, or $75,000, and you’ll pay the balance of $25,000 in cash at closing. However, balloon mortgages
are not like most residential bank mortgages that are self-amortizing, where you pay some amount of principal and interest for either a 15 or 30 year term, every month, like clockwork. Instead, to keep monthly payments reasonable, a 15 or 30 year amortization schedule may be used, as in residential mortgages, however the actual term of the mortgage is much shorter, say between one and ten years. The most common ones I’ve seen usually are in the three to five year range. So obviously, if you’ve been making monthly payments using a 30 year amortization schedule for a 5 year balloon mortgage, quite a lot of principal will be have to be paid off at the end of the term. And this remaining balance is known as the balloon payment.

Doing some simple math
Going back to our example above, we can use our basic mortgage calculator in our resources section here, and simply turn it into a balloon mortgage calculator. Let’s say we use a 4% interest rate with a 30 year amortization. With a mortgage of $75,000, our monthly payment would be $358, and at the end of 5 years, we would have paid down the principal to $67,704, having paid out $14,454 in interest in the five years of the loan. That $67,704 represents our balloon mortgage amount. If we don’t pay it off at the end of the term, the seller gets his property back. Naturally, that would be bad for you.
The refinancing solution
So what if you don’t have the $67,704 sitting around in your bank account at the end of the five years? Again, a simple solution. You
would go out and refinance the property with a commercial bank for this remaining amount, your balloon payment. This is extremely common, and a very accepted practice. Most banks are amenable to offering refinance mortgages because by the time your first mortgage is due, you’ve increased your equity in the property substantially – a fact that only helps you qualify even more for a commercial bank’s underwriting standards. Over a five year period, you may be able to build up an extra ten to twenty percent in equity valuation on your investment property. And banks traditionally want to ensure that you have at least twenty-five to thirty percent of your own funds already invested when they go to offer you any mortgage on an investment property.

Playing the leverage game
I have written in a prior article here how owner financing offers one of the great advantages of property investing – namely, leverage. I have
noted how “any money you don’t have to put up yourself when you buy investment property offers you the opportunity to increase your leverage on the purchase. And if you don’t have to borrow from a bank (or worse, a hard money lender) then you will be saving your credit line possibilities for further down the road. And if an owner is willing to take back mortgage paper for at least some part of the purchase price, you will be ahead of the game. Even if that amount is small, or not a first mortgage, it will benefit you. Every little bit of leverage goes a long way. Of course, if you can obtain a first mortgage from the seller, even better still.”

Using your time wisely
Always remember that chasing owner financing may not be the best use of your time. I have also recommended here that “while owner financing helps you greatly in increasing your overall financing leverage and future options, don’t waste your time making it your number one pursuit when searching to buy investment property. It is still an elusive task and will take an inordinate amount of your time. It would be better to use your time more wisely – time that could be spent on more fruitful property searching. Don’t pass up a great deal
simply holding out to obtain seller financing. But if you do manage to come across a willing seller offering some amount of owner financing, by all means, don’t pass it up.

You’ll negotiate just as hard as you would normally – but now you’ll be negotiating not just on price, but overall terms of the mortgage as well: interest rate, amortization schedule, and payoff term. Expect any owner financing to be short term – usually 1 to 5 years, but with amortization based on 15 or 30 years, with a balloon payment at the end of the overall term. Like with commercial paper, you’ll eventually have to refinance the overall remaining mortgage amount at the end of the term.” However, by now you should understand that holding a mortgage with a large balloon payment is not so scary as it might seem. The ability to refinance at some point down the road with a much greater equity position in the property will make it much easier to refinance. And that should give you the confidence to move forward and be more accepting of balloon mortgages because of the tremendous leverage they can offer you.
photos courtesy of commons.wikipedia.org, worldpropertychannel.com, allstate.com, mediacenter.dw-world.de, allmandlaw.com