Balloon Payment Guide: How a Balloon Payment Works

A balloon loan is a short-term amortized loan in which the borrower pays off the bulk of the loan in a single payment—called a balloon payment—at some point during the life of the loan. As opposed to a down payment on a traditional home mortgage, homeowners who have a balloon mortgage pay off the bulk of their loan at the end of the loan’s term after making regular monthly payments for a period of time.

A payment schedule like this allows borrowers to make lower recurring payments on the loan balance than they would with a long-term amortized loan. Interest rates are also typically lower with this type of loan. Balloon payments can apply to home loans or personal loans, but they most often come into play with large, commercial loans.

A balloon payment allows a borrower to make relatively low loan payments with a set interest rate for an agreed-upon period of time before the loan term ends. At some point during the life of the loan (usually in the final payment), the borrower pays off the bulk of the money they owe the lender with a balloon payment, which is a large payment that serves the reverse purpose of an upfront down payment.

The lender will use an amortization schedule to determine what a person’s balloon payment is, though the loan term will be far shorter than this schedule. Balloon payments are typically larger than many individuals are able to pay, so many people who choose balloon mortgages try to refinance their mortgages or sell their homes before the end of the loan term.

Though balloon payments may be costly and put pressure on the borrower when the due date rolls around, some people (like individuals who have a bonus structure to their income) may prefer them. Here are some of the potential advantages to taking on a balloon mortgage.

• Lower interest rates: Balloon mortgages typically have lower interest rates than a long-term, fixed-rate mortgage or adjustable-rate mortgage. Depending on the term of the loan, borrowers may also end up paying fewer interest payments than with long-term loans.
• Lower monthly payments: A balloon loan will typically involve lower monthly payments than other kinds of amortizing loans because the monthly payments take place over a longer amortization schedule than the loan term.
• Ideal for short-term purchases: If a homeowner is planning to only live in a property for a short period of time, a balloon loan allows the homebuyer to pay less money in monthly payments while giving them the freedom to sell the property and avoid the balloon payment entirely.

Paying off your home with a large balloon payment may be attractive to some buyers, but they can be risky and potentially less reliable than a conventional mortgage. Here are some of the potential disadvantages of taking on a balloon payment mortgage.

• Risk for default: If you reach the end of your balloon loan term and are unable to pay the final balloon loan amount, you will be forced to default on the loan. This means that the lender can foreclose on the property, which can spell devastating implications for your finances and credit score.
• Fluctuating market values: Many borrowers may find themselves unable to pay the lump sum payment at the end of a balloon loan, and they plan to refinance their loan into an adjustable mortgage loan beforehand. However, if your property has lost value when it comes time to refinance, you may end up paying more money than your property is worth.
• Less attractive to lenders: Most traditional lenders may be reluctant to grant private individuals a new loan on a balloon schedule because there is more inherent risk in this type of transaction.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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