How to prepare for a balloon payment

Question

I posted this on the commercial investing forum but haven't had much luck with responses. Maybe someone who works in commercial financing can help me out?

I'm looking at a 100% leveraged deal on a 6-plex in a college town. This property should cash flow even (or very close to it) as a fully leveraged deal including expenses and should be an excellent appreciation play.

I'm putting 10% down through a cash out refi on another SFH I own outright, with some remainder coming from a second loan on my primary residence. Seller is carrying back the rest at 5.75% (seems a bit high but no origination fees) on a 1 yr arm (he has one year left on his arm with the bank)...at which point the rate would fluctuate based on prime just like his commercial loan. This loan will be on a 25 yr amortization schedule with a 5 year balloon.

I'm a bit nervous about the balloon because if the property doesn't appreciate in five years I'll only have ~7% (aside from my leveraged 10% downpayment) in equity and will need to come up with a significant sum to get my LTV sufficient to refinance with a commercial lender.

Am I looking at this correctly or will a bank consider the 10% leveraged down payment I have included in the deal as equity, putting me at 83% LTV?

Chris Mason · Answer

Hi @Stanci March,

Best suggestion I've got: at around the 2 year mark, attempt to refinance it with a normal commercial loan. Assume the answer will be "no." But pay attention to the reasons why they said no, not just the "insufficient equity" part, but the other reasons too. Great, now you've got a "to-do" list. Try again at the 3.5 year mark. If they say yes at that point, great! If they say "no" again, then you've got a second "to-do" list and should be ready to rock in time to close on the refinance at the 5 year mark, 18 months later.

Andrew Johnson · Answer

@Stanci March My (limited) experience with commerical loans is that they are 5-7 year fixed with the 20-25 year amortization periods.  You’ll have some principal paydown but not a ton.  Not to mention that your interest rate (to the owner) isn’t fixed for 4 out of the 5 years.  So you really need to look at amortization tables and take a guess as to how much of the payment will really be going to principal and what the loan balance will be 5 years.  You could be in great shape even with higher interest rates. Or not.  Either way it can’t hurt to figure it out.

Stanci March · Answer

@Chris Mason, I love that approach! Thanks!

Andrew Johnson · Answer

@Stanci March 30 year fixed-rate loans for commercial multifamily?  I sure hope it makes a comeback!

Stanci March · Answer

@Andrew Johnson, my bank president lender tells me that fixed rate loans for rental property is making a comeback, he's hoping to have some options possibly within the the next 3-6 months.

Andrew Johnson · Answer

@Stanci March It's admittedly tough to look at any deal if you try to forecast rising interest rates into future debt payments, etc.  Most of the time you just have to look at the downside risk if things go bad.  There's a huge difference between a downside being a.) make less money, b.) break-even, c.) lose a little money, and d.) lose the property.  Believe me, I know the breakeven interest rate for my commercial loan in 5 years and if rates rise faster/higher than anticipated I'll do the lunatic thing that likely paydown some additional principal before I refinance or when I refinance.  Sometimes you can offset that risk with a healthy W2 income (to get you through a rough patch) but it sounds like that for you the downside would eat into your savings in a non-sustainable way.  I think (personal opinion) it's also why commercial lenders like to see net worth higher than the loan balance.  It's not a guarantee that you (the buyer) won't walk away but it does help to de-risk the deal for a lender.

Stanci March · Answer

@Andrew Johnson, I went back and re-ran the monthly debt service based on various interest rate scenarios. I'm not going to do this deal (as it's currently constructed at least) and I owe you a debt of gratitude for that. At a 7.5% APR, I could end up underwater by about -$1,500/mo. I could likely survive that for a couple of years before getting the building sold, but way more risk than I'm willing to take.

Stanci March · Answer

Great advice. Just to clarify; are you saying I should run the scenarios with different percentages but keep on the same (20-25 yr) am schedules? Would that be typical on a commercial loan?

The loan balance would be smaller after 5 years of principal reduction. Not sure how much that offsets potentially higher interest rates but certainly important projections to calculate in advance.

How to prepare for a balloon payment

Most Popular Reply