Loans providing for balloon payments require the payment of interest and the redemption of part of the principal during the term of the loan; the outstanding principal will then be repaid in full upon maturity (by selling the property or refinancing), unless the term of the loan is extended.

In this case there is a non-zero outstanding loan balance at the end of the loan term, thus allowing the borrower to make periodical payments that are lower than those under the provision of a fully amortizing loan. The value of the outstanding loan balance at the end of the loan term is generally referred to as a balloon payment (BP).

In order to calculate the value of the constant periodical payment (CP) the present value of an annuity formula is applied, solving it for CP. The value in time of the balloon payment is also considered, assuming 12 periodic (monthly) payments (per annum).

EXAMPLE 4.2

In the example in Figure 4.2 during the initial phase (interest-only maturity) only interest is paid, while the principal is repaid only later (from Year 4).

FIGURE 4.2 Pre-amortizing (semi-bullet)

from which CP can be calculated as:

4.4 FULLY AMORTIZING REPAYMENT PLANS

Fully amortizing is the most commonly used form of repayment for financing in the real estate sector. A constant periodical payment – monthly, quarterly, or annually – is calculated based on the loan value at a fixed interest rate. Each periodical payment thus contains both an interest payment component and the repayment of principal. The interest payment component is simply calculated applying the relevant interest rate (fixed or floating) to the outstanding loan

EXAMPLE 4.3

In the example in Figure 4.3 during the initial phase interest is paid and the principal is partially repaid, while the balance will be repaid only at maturity.

FIGURE 4.3 Repayment of a loan with balloon payments

balance at the beginning of the period, while the repayment of the principal is the difference between the constant payment and the interest payment.^{[1]}

For loans which are repayable in instalments, a repayment plan will be agreed upon in advance, which may come in different forms.

[1] In Microsoft Excel the PMT and PPMT formulas respectively are used to calculate the amount of the instalment and the outstanding capital.

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