An important point to look at is the difference between a balloon on an investment versus a balloon on primary residence. We will assume that we are talking about investment properties and also that the investment cash flows and made sense to buy in the first place. If those 2 assumptions are true, then the balloon doesn't have to be scary.
Let's say you have a commercial property consisting of 10-units (apartments, retail, whatever, just think in general terms for now). You have analyzed the investment and it meets your goals for cashflow and ability to support it's own debt service. You borrow money on a 20 year amortization with a 10-year balloon. Let's also assume that there is a rate adjustment built in for year 5, since that is fairly common in commercial lending.
Where we are with interest rates today we may never see again in a life time, rates will likely inch up over the next several years. Typically, interest rates adjust to curb inflation as the economy starts to improve. I am not an economist so I am not going to throw out any specific prediction, other than to say they will probably go up. My uneducated guess would be that in five years they may be up a couple points.
So tackling the rate adjustment first, you should look down the road at a possible rate bump and make sure that your property can support it. Yes, this will bite into your net income BUT, as @Joel Owens points out, many commercial leases have rent bumps written in to them. If you are renting apartments, you may be able to bump rents somewhat to keep up with your increased interest (and other) cost. This is, very simply, why inflation happens by the way. In the end, most likely if you are managing your asset well, you won't see much of a change on net income even if the rate bumps a few points.
Now for the balloon. Let's say you buy a $ 500,000 property and put 20% down, so you are borrowing $ 400,000 on a property that we will assume was in a stable market and really worth the purchase price you paid when you bought it. Your Loan to Value is 80%. Let's assume that the market remains stable and that there is no real appreciation in value. Let's also assume so I have some numbers to plug that there is no rate adjustment in year 5 and that you borrowed the money 20/10 at 5.8% interest. I'm doing this to simplify the analysis, so bear with me. Fast forward 9 1/2 years and you start to panic over the balloon. Check out these numbers:
You have paid $ 2,819.76 every month on time for the last 9.5 years. Your lender contacts you, or you contact your lender, and you learn that they have chosen NOT to renew the mortgage for another 10 years. As an aside, they MAY choose to renew at a new rate and you may decide to do so. For my example, though, we are assuming the worse case and they are calling the debt due. To keep our analysis easy, I am going to also assume that you have to refinance and do so exactly at year 10, so you have made 120 payments.
So, at the end of the 10th year, your principal balance is approximately $ 256,298. Assuming still, no appreciation in property value, your LTV is now just over 51% due to the loan amortization. My bet is that if your payment history is good, the asset has been maintained, and there are no major red flags, you will have no problem AT LEAST refinancing the principal balance remaining. It is also quite possible that you will not only be able to finance the principal balance, but you may also take cash out and walk away with cash in hand to put into another investment. You will then have leveraged your equity to use for even more investments.
Carefully managed financing doesn't have to be scary. Understanding it helps. Many of our loans are commercial. Closing costs can be higher than residential loans. However, being able to cash out offers a lot of options. Keep in mind that banks WANT to lend money. A mortgage held by a bank is an ASSET on their balance sheet that creates a return, in the form of interest. They don't want too much cash sitting idle. If you present them with a fair risk (you pay your bills, the asset/property is stable and well managed, etc.), they will want to lend money to you now and also later when your balloon is due.
