What is a Balloon Payment on a Commercial Mortgage?
Balloon mortgages are common in commercial real estate. Set up as two-step financial products, the borrower makes payments for a certain number of periods before a final payment to pay off the remainder of the loan. This last payment is called a balloon payment because of its large size compared to the smaller increments paid up until that point.
What is a Balloon Note?
A balloon note is not the same as an adjustable-rate mortgage, where a borrower benefits from an introductory interest rate or low monthly payments. As a balloon payment becomes due, many mortgage holders may try to sell or refinance in order to recoup the equity in the property or refinance with the lender.
A typical residential mortgage may be fully amortized, which means the borrower makes the same payment for the life of the loan, unless it is refinanced or paid early. However, in commercial real estate finance, loans are generally structured as balloon mortgages in which only part of the debt is amortized, with the balance due as one lump sum.
For example a 5/25 loan has its principal and interest payments calculated based off of a 25-year amortization, but the loan becomes due in full at the end of the last month of the 5th year. Generally, if loans like these carry prepayment penalties, the prepayment penalty is waived in the last 90 days before maturity so the borrower can refinance or sell without being penalized for doing so.