Balloon Payment

A balloon payment refers to a significant sum of money that is required to be paid at the conclusion of the term for a balloon loan.


What Is Balloon Payment?

A balloon payment is made at the end of a balloon loan’s term to pay the remaining balance. This payment is significantly larger than all the repayments before it. A balloon payment is usually used in loans where the monthly payback amount is substantially lower than a traditional fully amortized loan. 

Balloon Payment vs Fully Amortized Payment

A balloon payment is associated with a balloon loan where all prior payments are relatively smaller than the final single payment that clears the loan. In a fully amortized loan, at the end of the term, the remaining balance needs to be zero to clear the loan. 

Where Is Balloon Payment Used?

A balloon payment is most commonly used for the following types of loans:

Mortgage

A balloon mortgage is suitable for borrowers willing to sell off the property by the end of the term. Balloon mortgages are about 5-7 years long. After the term is complete, the borrower pays the remaining balance as a balloon payment. In some cases, the monthly payments are only for interest, hence, the remaining balance equals the amount loaned.

Auto-loan

Balloon payments are often a part of auto loans. It is suitable for users who want to secure a vehicle but do not have the means. 

Business Loans

Start-ups benefit from balloon loans as they have a limited amount while starting the company, but if they have a good financial record and a trustworthy credit history, they can take out a balloon loan. The balloon payment would be easier to make from the profit the company makes during the loan period. But the risk of the business failing or experiencing a loss will remain.

Advantages and Disadvantages

The advantage associated with balloon loans is primarily the initial smaller payments required compared to fully amortized loans. Furthermore, it has a shorter underwriting period resulting in low transaction fees and administrative costs. And lastly, balloon payments give the best loan structure for borrowers looking to re-sell their assets soon. In such cases, the selling price covers this payment.

But in a collapsing economy, prices would drop, and the amount received from re-selling might not be enough to cover the balloon payment. The borrower would have to default on their loan and accumulate debt or risk losing their net worth.