When choosing a commercial loan, always check to see if it includes a balloon payment. This large payment at the end of your loan’s term could mean that you will either need to pay a very large sum out of pocket or refinance your loan. The Small Business Administration (SBA) 504 loan has no balloon payment, and can also provide refinancing for qualified loans with balloon payments.
What Are Balloon Payments?
When you take out a conventional loan, you negotiate a number of conditions, including the amortization period and the term of your loan. The amortization period is the length of time it takes to pay back the principal and the interest on your loan at the rate you have agreed to. The term of the loan is the length of time you will be making these payments.
When the amortization period and term are the same, there is no balloon payment. A loan of this type is referred to as “fully amortized.” You pay the same amount every period until the end of the loan. If the loan is not fully amortized, it is possible that you will have a 20-year amortization period and a 5-year term. At the end of those five years, you will have a balloon payment due that is equivalent to 15 years of payments rolled into one.
Balloon payments have been a cornerstone of the mortgage system for a long time. Historically, and sometimes today, the interest is paid during the term of the loan and the principal is repaid as a single balloon payment. That financing could have a structure similar to this:
| Loan amount | $1,000,000 |
| Loan rate | 5% |
| Amortization period | 20 years |
| Loan term | 4 years |
| Monthly payments | $6,599.56 |
| Balloon payment after the fourth year | $877,620.15 |
A loan with a balloon payment will often have a lower interest rate than fully amortized options, and there are situations when the balloon payment is advantageous to the borrower. If you are confident that you will have the funds to make the balloon payment at the necessary time, the loan may provide low-cost access to capital. When inflation is high, the balloon payment will be worth less than when you took out the loan.
There is a risk involved in a loan with a balloon payment though. Many balloon payments that came due in 2008 were larger than the value of the mortgaged property. Borrowers who were unable to make the balloon payment were unable to refinance it as well, since the property could no longer serve as adequate collateral.
Usually, borrowers plan in advance to refinance their loan before the balloon payment comes due. This means starting over from the top—shopping for a new loan with new conditions and possibly another balloon payment. The SBA 504 loan is one way to refinance your loan without tacking on another balloon payment.
Refinancing With an SBA 504 Loan
The SBA Refinance Program was made to help ease the financial burdens of small business owners and allows conventional loans to be refinanced with better terms. You can avoid, or at least drastically reduce, a balloon payment by refinancing with an SBA 504 loan, which is always fully amortized.
A 504 loan can be used to refinance:
- the purchase of land or buildings
- the construction of buildings
- the purchase of equipment with a service life of ten years or more
- the improvement, upgrade or renovation of buildings
The loan must be at least two years old, and you cannot use a 504 loan to refinance loans that already have a government guarantee, such as SBA or USDA loans.
You can refinance up to 90% of the current value of an eligible property, or 85% if the refinance includes cash out for eligible business expenses (salaries, rent, utilities, inventory, etc)
The 504 refinance loan has three parts:
- The first is a loan from a conventional lender for at least 50% of the total amount. You and that lender determine the amount and conditions of that loan, which becomes your first mortgage.
- Your CDC facilitates a separate SBA loan of 40% of the total, up to $5 million, at a fixed, below-market rate. This will be your second mortgage.
- You, the borrower, contribute at least 10% equity to the loan as down payment. Usually the equity in property being refinanced covers this requirement.
It is worth noting again that the 504 loan never has a balloon payment. If you are looking for a commercial loan and you want to avoid having to refinance it in the future, starting with a 504 loan is an effective strategy.
You can find out more about obtaining a 504 loan or using the 504 loan to refinance your current mortgage from one of TMC Financing’s 504 loan experts. TMC is an SBA Premier Certified Lender and a high-volume loan provider. With over 35 years of experience, TMC can help you find the financing that is best for you and guide you through the 504 loan process. Contact TMC Financing today.
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