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Rookie Reply: Loan Amortization and Balloon Payments Explained

Real Estate Rookie Podcast
6 min read
Rookie Reply: Loan Amortization and Balloon Payments Explained

This week’s question comes from Neil on the Real Estate Rookie Facebook Group. Neil is asking: I’m reading a book on financing strategies — if a loan is amortized over thirty years, how is there a balloon payment at fifteen years? What’s the difference between the two?

Most real estate investors don’t run into things like balloon payments until they’ve started taking loans from private lenders or use seller financing. Balloon payments allow investors the chance to refinance earlier or pay off a loan in its entirety while also giving a seller or lender the cash they want.

Considering a balloon loan? Here’s what to know:

  • A loan is amortized over a set amount of years and interest is usually paid before principal
  • Balloon payments force the lendee/investor to pay back the unpaid loan amount at a certain year mark
  • Refinancing, paying off a property, or selling a property are ways to fund a balloon payment
  • Balloon payments force investors to think further in the future for better exit strategies 
  • And more in the episode…

If you want Ashley and Tony to answer a real estate question, you can post in the Real Estate Rookie Facebook Group! Or, call us at the Rookie Request Line (1-888-5-ROOKIE).

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Listen to the Podcast Here

Read the Transcript Here

Ashley Kehr:
This is Real Estate Rookie episode 134. My name is Ashley Kehr, and I’m here with my co-host, Tony Robinson. Tony, can you tell everyone what this podcast is?

Tony Robinson:
Ashley, I would love to that is my absolute favorite part of this show is introducing the new listeners to what we do here at the Real Estate Rookie. But we are here to focus on the very beginning of your real estate journey, and we do that because we always stop and say, “Wait, explain that. Let’s drill down on that,” and we don’t just gloss over a lot of those beginner terms, because we know that those are the things you need to know to really jumpstart your investing career and find financial freedom through real estate investing. So that’s what we do, Ash. What do you think? Do you agree? Am I on target?

Ashley Kehr:
Yeah. So whether you are trying to get your first deal or learn what real estate investing even is, or trying to get your next deal, you have come to the right place. If you guys have a specific question for us, leave us a voicemail at 1-888-5ROOKIE and we may play it on the show. So on today’s episode, our Saturday episodes, it is the wonderful Rookie Reply where we take your guys’ questions and we answer them. So, Tony, what is today’s question?

Tony Robinson:
So today’s question comes from Neil Adams and Neil asked this question on the Real Estate Rookie Facebook group. So if you’re not in that Facebook group, make sure you join, 30,000 plus members, lots of engagement. I honestly think it’s the most active, the most engaged real estate Facebook group geared towards new investors on the planet. So if you’re not in there, get in there and if you’re on Instagram, be sure to follow me and Ashley on there. She’s @wealthfromrentals. I’m @tonyjrobinson. So today’s question from Neil says, “I was reading a book on financing strategies and an example of private lending partnerships came up and they said that the backer loaned the real estate investor $167,000. That loan was then transferred into an LLC for 30 years at 5% interest with a 15 year balloon payment. What does that even mean? Why 30 years if there is a balloon payment after 15? What is the difference?”
So Ashley, there’s a few numbers thrown around. We got the 30, we got the 5%, we got the 15 year balloon payment. Let’s break it down. What are some of the terms that are associated with that 30, that five, and that 15 that a rookie should know?

Ashley Kehr:
Okay. So first of all, the 5% interest rate, that is the interest you are going to be paying on the money you are borrowing. The 30 year amortization is the amount of your loan and how the payments are going to be broken down. So if it’s 30 year amortization, that dollar amount, let’s say it’s $100,000. That $100,000 dollars is going to be broken out into monthly payments over 30 years. So if you’re looking at an amortization schedule, your principal and your interest is broken out over 30 years, your payment is going to be lower than it would be if it was over 20 years or 15 years, because you’re going to be making higher payments every month if it’s a shorter period of time that that loan is broken out into. So that’s an amortization schedule.
Go ahead. If you haven’t looked at an amortization schedule, this is your call to action for the week. Google amortization schedule and just type in $100,000, 5%, 30 years into it, click schedule, calculate, whatever it says and then view the actual amortization schedule. It will show you month one, this is how much you’re paying in principle, so how much money you’re paying back to the loan amount. Then it will be how much interest you are paying for that month’s principle and then it will be the total of your monthly payment right there. Then it goes through every single month over the next 30 years to show you what your payment will be, and it will stay the same. If have a fixed rate of that 5%, your payment will stay the same, but your principle and interest will be broken out differently.
So in the beginning, your payment, the majority of your payment is going to be going towards interest and then very little to principle. Then it reverses. As you’re towards the end of that amortization schedule, a bigger chunk is going to be going towards your principle rather than interest. That is just because you have a larger balance in the beginning of what is owed back to the bank or your lender, so that you’re going to be paying more interest than you are principle.
Moving on to the next number, the 15 year balloon payment. So even though your loan is amortized over those 30 years, at year 15, whatever that balance is that’s due, that’s going to be what’s owed. So say by year 15 you’ve paid down the mortgage to $60,340. I have no idea if that’s even close to accurate of what it would be, but just roll with me. That is the amount that you would then owe back to the bank or to the lender. So the advantages of having a long amortization period is your payment is low, even though you do have that balloon payment at 15 years instead of amortizing over 15 years and having that zero balance.
A downside, a disadvantage, is that what if you don’t have that $62,000 to pay back the loan at year 15? So that’s where you have to be careful with these balloon payments is that this loan is not budgeting you per se, where if you have a fixed rate that’s amortized over 15 years and it’s zero, you know what your monthly payment is going to be every single time and you’re just going to pay that whole thing off. So make sure you have a plan in place, you have an exit strategy for when that balloon payment comes up. Are you going to pay that off with cash? Are you going to refinance the property and put it into another loan? So make sure you have a kind of plan in place for those balloon payments. Tony, what would you kind of add to that to explain it better?

Tony Robinson:
Ashley, that was a phenomenal explanation. We can just cut the episode right there. I don’t know if I can add anything to make that … No, I think you did a great job of explaining that. So just to kind of recap what you said, the 5% interest rate is what the money cost you, right? That’s your cost of borrowing that money. Right? [inaudible 00:06:31] what you get charged. The 30 year amortization period is how long or what timeframe your payments are spread out over and then your balloon payment is at what point you actually have to repay that loan either by selling, by refinancing or just paying cash to get it done. So, no, gosh, I don’t think I have anything to add. That was great. You made this one easy for me.

Ashley Kehr:
I also wish I had a whiteboard so I could have drawn it off. Well, thank you guys so much for listening to this week’s Rookie Reply and make sure you do your call to action and check out what an amortization schedule is and what it looks like. Definitely beneficial too. If you are doing seller financing and you’re putting together an offer, print out the amortization schedule for the financing that you’re trying to get that seller to hold for you and show them what their monthly payment is going to be after how many years, how much interest they will have made on the property too. So we will see you guys back on Wednesday. I’m Ashley @wealthfromrentals and he’s Tony @tonyjrobinson on Instagram. Thank you guys so much for listening.

 

 

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.