The balloon is fixed on the day the loan closes; the value it has to be refinanced against is not.
The balloon payment is the loan balance still outstanding at maturity: the original amount compounded at the loan rate, less the payments made, compounded the same way. A $30.0m loan at 6.0 per cent on a 25-year amortisation with a ten-year term leaves a balloon of $22.91m, 76.4 per cent of the original loan. Whether it can be repaid depends on what a new lender will advance against the property in year ten, not on the coupon the borrower has been paying.
Worked in full in The Real Estate Debt Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Most commercial mortgages amortise on a schedule longer than their term, so the last payment is a lump sum that has to be refinanced or paid out of a sale. The lender's question at origination is how much of that lump sum survives a bad decade. Every figure below is illustrative.
| Input | Value |
|---|---|
| Loan amount | 30.0 |
| Interest rate, fixed | 6.0% |
| Amortisation, years, monthly payments | 25 |
| Term, years | 10 |
| NOI at origination / cap rate | 3.00 / 7.0% |
| Value at origination (LTV 70.0%) | 42.86 |
| Good case: NOI growth / exit cap | +1.5% / 7.0% |
| Bad case: NOI growth / exit cap | -1.0% / 8.0% |
| Refinance lender: max LTV / min debt yield | 65.0% / 9.0% |
Monthly payment = L x i / (1 - (1 + i)-n) = $193,290, with i = 0.5% and n = 300
Balloon after m payments = L x (1 + i)m - PMT x ((1 + i)m - 1) / i
With m = 120: balloon = $22.91m; principal repaid = 30.0 - 22.91 = $7.09m, or 23.6 per cent
In Excel: =-FV(6%/12, 120, PMT(6%/12, 300, 30), 30) returns 22.906.
Over the ten years the borrower pays $23.19m, of which $16.10m is interest. Amortisation is front-loaded with interest, so less than a quarter of the loan is repaid in the first ten years of a 25-year schedule. The annual payment as a share of the loan, 7.73 per cent here, is the mortgage constant.
The balloon is fixed by the loan terms; the property's value in year ten is not. Grow NOI for ten years, capitalise it at the exit cap rate, and ask what a new lender at 65 per cent LTV and a 9.0 per cent debt yield would lend.
| Case | NOI at maturity | Value | Maturity LTV | Debt yield on balloon | New loan available | Refinance gap |
|---|---|---|---|---|---|---|
| Good | 3.48 | 49.74 | 46.1% | 15.20% | 32.33 | 0.00 |
| Bad | 2.71 | 33.91 | 67.5% | 11.84% | 22.04 | 0.86 |
In the good case the balloon is a formality. In the bad case the debt yield test is comfortable, 11.84 per cent against a 9.0 minimum, but the LTV test binds: 65 per cent of $33.91m is $22.04m, and the borrower has to find $0.86m. The property can lose 17.8 per cent of its origination value, to $35.24m, before the balloon stops refinancing at 65 per cent.
A refinance gap is not a default by itself: the sponsor can pay it down, bring in preferred equity, or ask for an extension. But it is the point where the lender's recovery starts to depend on the sponsor's willingness rather than the property's value.
Amortisation is the lender's main lever on the balloon. Same rate, same term, same bad case:
| Amortisation | Annual debt service | Balloon | Maturity LTV, good | Maturity LTV, bad | Bad-case gap |
|---|---|---|---|---|---|
| Interest only | 1.80 | 30.00 | 60.3% | 88.5% | 7.96 |
| 30 years | 2.16 | 25.11 | 50.5% | 74.0% | 3.06 |
| 25 years | 2.32 | 22.91 | 46.1% | 67.5% | 0.86 |
| 20 years | 2.58 | 19.36 | 38.9% | 57.1% | 0.00 |
Interest only turns a $0.86m bad-case gap into $7.96m, more than nine times larger, on the same property and the same decade. Each step longer in amortisation lowers debt service, which helps coverage during the loan, and raises the balloon, which hurts the exit. The two tests pull in opposite directions, and a loan that is sized only on in-place DSCR will drift towards the long amortisation that makes the exit fragile.
Lenders use three tools to manage the balloon rather than the coupon. Amortisation shrinks it, as the table shows. A cash sweep triggered by a debt yield or DSCR test shrinks it faster when performance weakens, which is exactly when it matters. And extension options give the borrower time to refinance, at the price of conditions such as a minimum debt yield on extension and a paydown. Each changes the number the exit test is run on, and a credit paper should show the balloon under the structure actually proposed.
The frequent error is to test the balloon against today's value and today's lending terms: $22.91m against $42.86m looks like a 53 per cent LTV and no risk at all. The test belongs in year ten, on a value that has absorbed a cap rate move and a weaker NOI, and against the refinance lender's terms, not the original lender's. The second error is to model monthly-pay loans with annual compounding; for a balloon the difference is small but it compounds through every downstream test.
Compute the balloon with FV on the actual payment schedule, here $22.91m, then size the refinance on a stressed value at maturity. On this loan the bad case leaves a $0.86m gap at 25-year amortisation and $7.96m interest-only. The book's sizing and exit-test model, which runs the exit test on a good and a bad case for your own loan, is in the free workbook for this case; to work backwards from the takeout lender's tests, see the NOI a loan needs to refinance.
Use FV on the actual payment frequency: =-FV(rate/12, months elapsed, PMT(rate/12, amortisation months, loan), loan). For a $30.0m loan at 6.0 per cent on a 300-month amortisation, after 120 months it returns 22.906, a balloon of $22.91m.
Less than intuition suggests, because early payments are mostly interest. On a 25-year schedule at 6.0 per cent, ten years of payments totalling $23.19m repay only $7.09m of a $30.0m loan, 23.6 per cent; the other $16.10m is interest.
Longer amortisation lowers debt service but raises the balloon. In the illustrative bad case, the balloon after ten years is $19.36m on 20-year amortisation, $22.91m on 25, $25.11m on 30 and $30.00m interest only, and the refinance gap at 65 per cent LTV rises from nil to $7.96m.
This article is one calculation from The Real Estate Debt Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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