As you already know, a commercial loan is a short-term funding arrangement between a business like yours and your banking partner. Many companies use commercial loans to finance the purchase of fixed assets like real estate, to invest in necessary equipment and machinery, or to cover financial setbacks.
What you may not know is that there are several different ways to repay a loan. You can make monthly payments like you do on your credit cards and other loans, of course. Another, perhaps lesser known, type of repayment plan is called a balloon payment (or bullet payment).
Here’s a look at what a balloon payment is, the risks and advantages of this type of repayment plan, and how to go about applying for a commercial loan with a balloon repayment plan for your company.
What is a Balloon Payment?
A balloon payment is a form of loan repayment where a large sum is due at the end of the loan period. This type of repayment plan usually offers lower monthly payments leading up to the larger lump sum.
A balloon payment can be part of a loan with both fixed or variable interest rates, and is commonly repaid over a period of 5-7 years for commercial loans. Balloon payments are far more common in commercial lending than in consumer lending.
Advantages of Balloon Payments
There are plenty of reasons why balloon payments are attractive to business owners. Most notable is that it allows you quick access to funds when you may not have the cash available for high initial payments. More traditional loan payments will have higher monthly payments spread out over time, while a balloon payment will require less cash outflow before the larger sum is due.
In addition to lower monthly payments, a balloon payment sometimes comes with lower interest rates. Due to the large sum guaranteed at the end of the loan period and the high credit score required from the borrower, lenders occasionally offer lower interest rates on this payment structure.
For businesses that are confident that they’ll have the cash available at the end of the payment period, a balloon payment can provide a better cash flow over the life of the loan. This type of payment is also common for business owners who believe they’ll be able to sell their business or commercial property before the lump sum is due.
A balloon payment is also attractive for those looking to refinance a current loan. If a business is in a position where monthly loan payments are too high, it can refinance to achieve lower payments with the hope of either selling the business or having the cash available when the lump sum is due.
Risks of Balloon Payments
The biggest risk with a balloon repayment structure is being unable to pay off the loan in one lump sum at the end of the loan period. The lump sum will typically be significantly higher than the monthly payments you’ve been making, so preparation and good communication with your bank will be key.
There is also an inherent risk with any commercial business or investment that things sometimes don’t go according to plan. If you were counting on an increase of funds from your business, either through operations or a sale, it’s possible that an economic downturn or an unexpected change in your industry can leave you short of the funds needed to make the lump sum payment.
How to Get a Commercial Loan with a Balloon Repayment Plan
If you’re interested in getting a commercial loan for your business, there are a few steps you can take to make the process easier. This includes:
- Know why you’re borrowing. Having a clear understanding of how the funds will be used can help you figure out the best repayment plan for you.
- Shop around for the best lending rates. Start by talking with your banker at Crown Bank and let’s see what we can do for you.
- Understand the fees associated with your loan. Don’t hesitate to ask questions about lending fees so you understand what you’re agreeing to.
- Organize all of your documentation. It can help streamline the lending process if you have all of your documentation ready to go. Talk with your banker about the specific documents you’ll need.
To learn more about the commercial loaning process, read our blog: Everything You Need To Know About The Commercial Lending Process.
If you’re specifically looking for a balloon repayment plan for a commercial loan, you’ll need good business credit to be considered for this option. Your credit is determined by payment history, debt, company size, industry risk, and how long you’ve been building credit. If you have more questions about balloon payments and commercial loans, don’t hesitate to contact us. At Crown Bank, we take pride in being a resource for you and helping you every step of the way.