What is a balloon payment?
A balloon payment refers to an installment payment due at the end of a loan term. There are a number of reasons you might want to consider a loan with a balloon payment, particularly if you believe you can pay it off in a relatively short amount of time.
A balloon loan, like a mortgage or commercial loan, is treated like a short-term loan with benefits. Rather than require you to make payments on the entirety of your loan, the lender asks you to make payments on a portion of the loan.
The draw of a balloon mortgage is that lenders amortize the loan (the amount you will pay each month) over a 30-year term rather than the short 5- to 7-year term when you will actually have the loan, making the monthly payments less expensive.
Consider the mortgage basics.
Balloon payment example
If you are purchasing a home in a high priced area, a lender may offer you a balloon mortgage as an incentive to buy. Say you need to borrow $500,000 to purchase a home, and the current interest rate on a traditional 30-year mortgage is 5 percent, but the interest rate on a balloon mortgage is 4 percent. If you take out a traditional 30-year fixed mortgage on the $500,000 loan, your principal and interest payment will be $2,684 per month. Due to the lower interest rate of the balloon mortgage, this type of loan will cost you $2,387 per month, a savings of $3,564 per year.
The caveat is that at the end of the 5- to 7-year term you will need to make one final balloon payment of $432,684 to pay off the remainder of the mortgage. This normally means that you must refinance the house, sell it or convert the balloon mortgage into a traditional mortgage at whatever the current interest rate is.
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