Never agree to a balloon payment.
Posted by John Reed on
I recently did a zoom with the Chicago CCIA—Chicago Creative Investors Association. It is individual real estate investors.
Among other things I told them no balloon payments. 30-year fixed-rate self-amortizing mortgages only. One guy asked what if you cannot find any such mortgages because all the lenders refuse to make 30-year self-amortizing mortgages on apartment buildings?
So don’t buy apartment buildings.
Balloon payments being all but universal in apartment buildings these days is one of the main reasons for my recent book An American Principal Residence is the Most Advantaged Investment on Earth: Maximize Yours! Chapter two is all the advantages principal residences have over all other types of investments including duplexes and apartment buildings.
Walk into a mortgage lender office and say you want a mortgage to purchase your principal residence and you get a big smile. For any other type of single family, like cash out, refi, you get less of a smile. For five-family and larger buildings, they may show you the door or offer you some “horror story of risk to you” mortgage with terms like five years balloon, 3 percent over prime, etc.
Balloon payments are extremely dangerous. Assumption is the mother of all screw-ups and agreeing to a balloon payment implies you assume that you will be able to refinance or sell before the balloon payment comes due.
I have been in this business 53 years. Sometimes, you can refi. Other times you cannot for various reasons. Sometimes you can sell. Other times you cannot for various reasons.
The most dangerous investors are those who had the bad luck to start their investing career during a boom market. They conclude that is normal and promptly take absurd—to an experienced investor—risks. Most such investors probably go down in foreclosure flames.
In my foolish youth, I agreed to some balloon payments. I made them all by selling. But I was very scared along the way.
Putting yourself over a barrel is a horrible prelude to a negotiation.
So you want to refi?
What is the purpose of the refi?
I have a balloon payment coming up.
Dollar signs appear in the lender’s eyes.
Same if a prospective buyer finds out you are selling because you have a balloon coming up.
There is a stark pattern in balloon-payment land. They are popular with young or novice investors. The more experience the investor has, the longer amount of time he will insist on before having to pay the balloon. And ultimately, he will refuse to ANY balloon payment, like me.
It has been said that there is no such thing as an old property manager. Experienced people know it is a thankless, litigious, too-low-paid job. Similarly, there are few such things as a very experienced real estate investor who will agree to balloon payments. They are rookie mistakes.
Principal residence financing is a sort of nice “neighborhood.” Balloon payment loans are a sort of “back alley” in a “bad neighborhood.” Stay out of those places. Making millions in real estate investing over the course of your career does not require risking balloon payments or tenants.
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