Just as homebuyers are seeing a spike in interest rates for mortgages, investors are seeing a spike in interest rates for commercial real estate loans to buy or build properties.
Interest rates for commercial real estate loans can vary based on several factors such as the property type and the borrower’s credit history, repayment history and current debts.
Although interest rates for commercial real estate loans have recently gone up in tandem with interest rates for residential mortgages, demand for commercial loans is expected to be strong throughout 2022. In fact, Lawrence Yun, chief economist at the National Association of Realtors, predicts that other than the office sector, the commercial real estate should perform well this year. However, demand may not be as vigorous as it was in 2021.
Whatever the landscape looks like, commercial real estate investors in 2022 face the prospect of paying more to borrow money than they did in the past several years. So, how does a commercial real estate borrower try to blunt the effect of rising interest rates? One option may be a balloon loan.
How Does a Commercial Balloon Loan Work?
A balloon feature can apply to a commercial mortgage or another loan that’s not fully amortized. When a loan is not fully amortized, the monthly payments are calculated as if the loan lasted, say, 15 or 30 years rather than the normal three to seven years for a commercial balloon loan.
A commercial balloon loan generally enables you to make lower monthly payments and perhaps make a lower down payment. Plus, these loans can charge lower interest rates than longer-term loans do; the rates can be fixed or adjustable.
However, because a balloon loan is not fully amortized, the borrower is supposed to make a lump-sum payment, or balloon payment, when the loan’s term concludes. This payment could add up to tens of thousands or even hundreds of thousands of dollars.
With a balloon loan, only part of the principal usually has been eliminated once the borrowing window closes. This means that at the end of the loan period, the lender expects the borrower to cover the remaining balance. Aside from coming up with cash for the balloon payment, the borrower could obtain a new loan (perhaps at a higher or lower interest rate), essentially refinancing the existing loan. Or the borrower might sell the property to avoid getting a new loan.
What Should You Do if Your Balloon Loan Is Maturing Soon?
Let’s say you have a balloon loan and it’s maturing soon. Amid today’s higher-interest lending environment, what, if anything, should you do with the loan? Four of the main options are:
- Pay off the loan. This means making the full balloon payment when the loan matures.
- Extend the loan. A lender may be able to give you a short-term extension, delaying the date that the loan matures. The extension might be 60 to 180 days.
- Renew the loan. As the original loan is about to mature, your current lender may underwrite another loan based on the original loan agreement. Since the original title policy and appraisal may be used, a borrower may avoid some loan closing fees with a renewal. A lender may enable you to renew a loan several times.
- Refinance the loan. This generally involves a new loan with new terms, including a different interest rate. Like a new loan, the borrower may have the added expense of loan closing fees such as a title policy and appraisal.
Are you looking for a commercial real estate loan? Lending specialists at Texas Regional Bank can help you decide whether a balloon loan or another type of loan is right for you. Schedule an appointment today to go over your options.