When you need farm loan financing, you have several payment options including the balloon loan. The balloon loan is temporary financing. It’s amortized over a long-term period, such as 20 or 30 years, but its maturity date is usually in a much shorter period, such as five years.
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Keep reading to learn why a balloon loan may be risky for your farm.
You May Owe the Full Principal Amount Quickly
The largest risk with the balloon loan for your farm is the amount of money you may owe in a short amount of time. Let’s say you borrow $300,000 for your farm and only pay off $10,000 of that principal in five years. At the end of five years, your balloon loan matures, which means you owe $290,000 in full at that time. If you don’t have it, you could go into default on the loan.
Now, there are options, but there is no guarantee that it will work:
- The current lender can renew your loan at the time of maturity.
- You can
refinance the funds yourself by securing a loan from another lender
Your current lender isn’t under any obligation to renew your loan at the time of maturity though. It typically depends on your current credit qualifications as well as the state of the economy at the time. The lender will make a case-by-case decision regarding whether or not to renew your loan.
The Terms May not be Favorable
You cannot predict what the economy will be like when your balloon loan matures. What if interest rates are through the roof or the economy is a downward spiral? These factors could affect your ability to secure a farm loan to refinance your current loan.
For example, if interest rates are much higher, making the payment unaffordable, you probably won’t qualify for the new loan, which leaves you at the risk of defaulting on your loan. Because no one can predict the future, it’s a risk that you take.
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You’ll Pay More Closing Costs
Whether you renew your farm loan with your current lender or you refinance the loan with another lender, you’ll likely pay closing fees.
Before you take your balloon loan, discuss your options to renew the loan with the lender. While the lender cannot give you a solid approval at the time of taking out the balloon loan, they can tell you the administrative costs of taking out the loan. This way you can weigh the pros and cons of renewing the loan should you be unable to pay the full balance at the time of maturity.
If you opt to refinance the loan with another lender, you’ll need to find a lender that you can afford, just as you would when looking for your fist farm loan. If you do look outside of your existing lender, try to
obtain quotes from at least 3 lenders. This way you can tell which closing costs are the most affordable as well as which lender offers the best terms.
The bottom line is that a balloon loan is risky. Unless you know beyond a reasonable doubt that your farm business is going to take off and you will be able to pay the loan at maturity, you take a risk. Make sure you have backup plans should you be unable to pay off the loan at maturity.
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