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Considering the best mortgage strategy to use when investing in real estate can be tricky. There are more options out there that people first realize, and knowing which one is the best fit takes some time and research.
One option is a balloon payment mortgage- a popular choice in commercial real estate loans and for developers using the BRRRR method. If you are not sure how balloon payment mortgages work- or you are but are not sure if they are right for you- you may be turning to online real estate calculators for some answers.
Before using a balloon payment mortgage calculator, you need to have some understanding of what the term means, how calculations work, and what they mean for your investments.
This comprehensive guide to balloon payment calculators has all the details you need to get started.
What Is a Balloon Payment Mortgage?
Balloon mortgages are fixed-term loans that work on a monthly payment schedule for most of the term and then require a large lump sum payment at the end of the loan to pay off the remaining balance.
Unlike traditional fully amortizing mortgages, balloon payments don't usually last more than seven years. They are comparatively short-term loans and have a lower annual interest rate than other types of mortgages.
How Do Balloon Mortgage Payments Work?
The monthly payment schedule on a balloon mortgage is worked out based on a 30-year amortization period, just like a normal mortgage- even though the loan term is only seven years.
Each month, the investor pays their mortgage, with the bulk of the amount going toward the interest payment. Sometimes, in an interest-only balloon loan, the monthly payment goes 100% to interest.
When the end of the loan term arrives, the investor must pay off the remaining balance in a lump sum- known as the balloon payment. This covers everything that is left and leaves them mortgage-free.
When Are Balloon Payment Mortgages Used?
One of the main reasons investors choose this type of mortgage is to save money on interest. The interest rate is usually lower, and because you pay it off after a much shorter time, the total interest paid is significantly lower.
Of course, the lump sum balloon payment at the end is risky, as there is no guarantee you will have the funds to cover it. That is why it is generally used by commercial real estate developers who expect an influx of cash or those who intend to refinance later.
By opting for a balloon payment mortgage, you avoid the fees for paying off a mortgage early, so it is a good option for people who are confident they will have the funds available to do so.
It is also a possible strategy for people who buy to sell. Lower monthly payments leave more money for renovations, and the money from the sale can cover the balloon payment. This is risky, as you need to have the cash before the loan term expires.
What Does a Balloon Payment Calculator Do?
A balloon mortgage calculator works out how much your monthly payments and balloon payments are likely to be based on the amount of money you want to borrow. They can also tell you the total interest you will pay and what your amortization schedule might look like.
How Are Balloon Mortgages Calculated?
The formula for calculating the payment schedule for a balloon mortgage is complex, as it accounts for annual interest and amortization. What makes it even more complicated is the amortization period being calculated as significantly longer than the actual loan term.
In the simplest possible terms, a balloon payment mortgage is calculated by taking the total amount of money a person wants to borrow, applying the annual interest rate, and working out a monthly payment schedule on the assumption that it will fully amortize.
However, the amortization period ends with the end of the loan, and the principal and interest payment balances become the final balloon payment.
The Variables and Things that Affect Them
Let's take a look at each of the variables in the calculation to gain a better understanding of how a balloon mortgage calculator works.
Loan Amount
The most important variable when calculating balloon mortgages is the initial loan amount. Before anything else can be calculated, you need to work out how much you need to borrow.
Most lenders will loan up to 80% of a property's value without requiring additional insurance. Look at the cost of the property you want to invest in and how much you can afford as a down payment. In most cases, you need at least 20% of the cost, but there are some exceptions.
When you know how much you need to borrow (and are sure you will be approved for the amount), you can input the loan amount into the balloon mortgage loan calculator.
Interest Rate
Next, you need to input your interest rate. Balloon mortgage interest rates are usually a bit lower than other mortgage loans, but it depends on the lender you choose.
The interest rate is important for your balloon payment calculation because it determines how much you need to pay on top of the initial loan amount each year. A higher interest rate means higher monthly payments or a larger balloon payment left at the end of the loan if you want to keep monthly payments to a minimum.
Loan Term
Like any loan, the length of time you have to repay it will impact how much you need to pay each month. It also affects how much interest you pay overall and, in this case, how much your balloon payment will be at the end.
A balloon payment mortgage is usually a short-term loan that lasts between five and seven years.
The shorter the term, the less interest you pay- but the higher your monthly payment and balloon payment will be.
Opt for a longer term, and you will pay a bit less per month and cut further into your balloon payment- but you will also pay more interest for the same loan.
Amortization Period
The amortization period on a balloon payment mortgage is worked out the same way as a regular fixed-term, fixed-rate mortgage.
An amortization schedule refers to the split between the principal and interest payment on the monthly payments on a mortgage. At the beginning of the schedule the payment goes mostly toward interest. With each monthly payment, the amount of money paid toward the principal loan balance slowly increases.
In a fixed-term 30-year mortgage, the payments are perfectly planned so the final payment clears both balances. With balloon payment mortgages, it never gets that far.
You can choose an amortization schedule of between 15 and 30 years with most lenders. Again, the longer the period, the lower the monthly payments and the higher the total interest. A shorter amortization schedule means you save on interest but need to pay more each month. It all comes down to what you can afford.
The only difference between amortization in a traditional fixed-rate mortgage and a balloon mortgage is that it never reaches the end. Balloon payment mortgages do not fully amortize. Instead, you follow the schedule until the end of the loan term, then pay the balance in one go.
Monthly Payment Options
Depending on your lender, you may have the option to choose interest-only monthly payments. This means you have a lower cost during the loan term but the entire loan amount to repay at the end. Some commercial real estate developers choose this option based on the assumption they will be generating enough income through the property to pay it off- but want to limit their expenses over the years while they develop and get things up and running.
Some balloon mortgage calculators offer this as a variable- others do not. You may also be able to input the amount you ideally want to pay each month. It will work out the rest from there.
Example of a Balloon Mortgage Calculation
In this example, we will look at a commercial development worth $1 million. The developer wants to borrow 70% of the cost, making the loan amount $700,000. They have checked with multiple lenders and have been approved for this amount at an interest rate of 4%, and they want to pay it back over seven years.
Let's review the details we have so far.
- $700,000 loan amount
- 4% annual interest rate
- Seven-year term
The developer wants to follow a normal amortization schedule of 30 years, paying the remaining balance after seven years.
Based on these figures, the balloon payment calculator predicts the following monthly payments and the expected balance for the end-of-loan lump sum.
- Monthly payment of $3341.91
- Balloon payment of $602,416.30
- Total interest of $173,930.20
By using the calculator, they can decide if this plan works for their investment strategy. Are the monthly payments within budget? Are they confident they will be able to repay that amount at the end of the loan? If the answers are yes, they can move forward. If not, they can reassess.
Let's look at the same example another way. Sometimes, the balloon payment amount is a set figure or percentage of the original loan. Lenders may arrange it that way to limit their risk factors.
If the developer in this case knows the balloon payment is going to be $600,000, they can reverse calculate the monthly payments.
This would make the monthly payment $3366.88 and the total interest $173,479.90- a slight adjustment from the original calculation.
How Are Balloon Mortgage Calculators Utilized in Real Estate?
The main reason people use balloon mortgage calculators is to establish how much they should expect to pay and whether or not they can afford it.
Some investors like the idea of a balloon mortgage but are unsure about the financial realities. The lower interest rates are appealing, but the high monthly payments and large lump sum payments at the end can put people off.
The best way to weigh up the realities is to input the numbers and see what they come back with. If you know how much you need to borrow and what interest rate you can get, you can find out how much the loan would cost you each month and what would be left to pay.
People also use it when they are considering their refinancing options for the future. If a developer intends to apply for a cash-out refinance, they can use a balloon payment calculator to see how much they would need to borrow to cover the lump sum.
What Does a Good Balloon Payment Calculation Look Like?
There is no good or bad balloon payment schedule- each one is different and depends on the individual loan.
The only real marker of whether a balloon mortgage calculation looks good or not is if you can or can't afford the payments.
If you know you want to use a balloon payment mortgage, but the numbers shown on the calculator don't work for you, you may need to look at ways to change it. The most obvious solution is to take out a smaller loan- meaning smaller payments and a more affordable balloon payment.
Always compare lenders to find the best interest rate and terms- some are more flexible than others.
Are There Any Limitations to Using a Balloon Payment Calculator?
It is important to remember that real estate calculators that predict mortgage payments are not 100% accurate. They can be very close if the numbers you input are the same as those used by your lender, but only the company providing the loan can tell you the exact details.
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Summary
Balloon loans are great for some investors but not for others. Using a balloon mortgage calculator can help you determine if the numbers work for you and how much you should expect to pay if you move ahead with a loan.
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