What is a Balloon Payment?
A balloon payment is defined as a significantly larger-than-usual payment due at the end of a loan, mortgage, or commercial loan.
When considering a balloon loan, it is important to know the status of your financial health and consider how you will be able to make the balloon payment once it’s due. Also, be aware that this type of loan requires discipline to save up for the big day. However, borrowers sometimes find themselves unprepared when it’s time to make the big payment, and to fix that they might have to give up all payments made in the past and then return the product or consider refinancing by taking another loan.
Understanding Balloon Payment
Suppose you are doing some Christmas cleaning around the house. You make a big list of all the things you need to get done by the end of the week, but when Sunday evening rolls around, you haven’t finished most of them. You find yourself having to get in all the chores in the last few hours of your weekend. Balloon payments are similar, where you’re saving a big chunk of your payments for the very end when you’ll owe them all at once.
This loan option allows the borrower to make lower or no payments for a period of time, leaving the borrower with lower monthly repayment costs in the initial stages of paying back a loan, in exchange for an enormous sum of money due at the end of the loan. This can only be done when the loan is not amortized, which means that a regular installment payment is not required.
What Types of Loans Can Have Balloon Payments?
Balloon payments are more common in commercial lending than in consumer lending because the average homeowner typically cannot make a very large balloon payment at the end of the loan.
In the case of a mortgage loan, balloon payments are pre-packaged into two-steps mortgages where there will be two rates of interest. These types of mortgages offer a fixed interest rate for a period of time in the first phase, and after this period, the interest rate adjusts according to the current market rate.
Engaging in a two-step mortgage is extremely risky because there is a chance of the rate being higher in the second phase.
The concept of a balloon loan is ideal for borrowers who struggle with a short-term shortage in cash but expect a strong cash flow before the loan expires.