Looking at buying my first investment property. I believe my lender is suggesting a 20 year amortization with a 5 year balloon. Is this a bad idea for an investment property? Hopefully this isn’t a dumb question. Thank you in advance!
First, there is no such thing as a dumb question, only dumb answers, lol.
You have not provided enough info to determine if a 5 year balloon is a good or bad idea for an investment property, as that is too vague and there is no one size fits all. Your current and potential future market conditions, the amount of the loan, the property type, your specific cash reserves, and many other factors will play a part in your decision. Many investors have 1, 3, 5, 7, or 10 year balloons in their loans and they select that for any number of different reasons. What you need to decide is if this particular property at this particular time with your specific strategy in mind will be beneficial or potentially detrimental to your investment.
If your plan is to hold the property for cash flow for longer than the 5 years, perhaps 10 years or more, then a full amortized loan would typically be a better choice (but not always).
The risks are, in 5 years, what if the value dropped below the value today, you would then need to bring cash to the table to refi that balloon loan out. Or perhaps loan rates are significantly higher in 5 years from today resining your debt service and decreasing your cash flow. These are things to consider when taking on a loan with a balloon.
That said, as a developer and flipper, I have balloons in all my loans as I am not holding them for any period longer than 1 year typically and if I go over 1 year, I can ask for an extension with my private lenders. This of course is completely different than a buy and hold strategy.
Commercial properties and the commercial loans associated with them are commonly 25 year amortizations with balloons of 3, 5, 7, or 10 year balloons.
You will have to sell or refinance in 5 years. With that in mind is it a great idea?
I got waxed by a balloon earlier in my investing career and lost money getting out of the property. I realize that someone will come on this thread and say 5 years from now you can refinance and your property will be worth a lot more etc. At the end of the five years your the one looking down the barrel of the bullet so your the one that has to decide if it’s a good idea for you or not.
@Will Barnard you definitely answered my question. There’s a property I’m interested in and the lender mentioned the balloon. It’s definitely a buy and hold for cash flow, so I may need to reconsider. Thank you for the info!!
@Account Closed I don’t think this particular market will thrive in the near future! However, I also don’t think the property will lose value. You made a good point. In the end I’ll have to figure it out. Thank you!!
@Tyrone Perry I am very anti-balloon unless you know you can be sure that you will have the assets to pay the loan off when the loan balloons. Most people just assume they will be able to be refinance. Possible they are right. Also possible that they are wrong. If the credit market tightens substantially or if the housing market declines 15% - 20% you could find it very difficult to obtain new financing to pay off the balloon.