What is a balloon payment?
A balloon payment is an installment payment due at the end of a loan term. Such loans don’t amortize at the end of the term, but rather have a larger-than-usual payment required at the end. Borrowers with a balloon-payment loan make smaller monthly payments over the course of the loan until the balloon payment is due.
For a conventional loan, payments are made every month until the last payment is due, and that last payment is virtually equivalent to every other payment. This is called amortization, and every payment can be calculated on the basis of the amortization schedule.
With a balloon payment loan, the borrower agrees that at the end of the loan term, the remaining balance will be a large lump sum rather than just another monthly payment. Because that unpaid balance wasn’t originally spread across loan term, the monthly payments end up being somewhat smaller until it comes time to make the balloon payment.
Balloon payments help borrowers afford a loan now provided they can still afford a larger sum later. But balloon payments can also refer to the payment made when a bond matures. With a bond, the bondholder may usually only get paid in interest, but when the bond matures, some bond issuers pay a one-time balloon payment equal face value of the bond.
Using Bankrate’s mortgage calculator, you can find out how much you’ll owe in the future.
Balloon payment example
Catherine wants to take out a 30-year mortgage so she can buy a home. However, right now she isn’t making as much money as she’d like, and can only afford monthly payments of around $400. The bank makes a deal with her: she can make $400 monthly payments, on an amortization schedule in which payments against interest gradually decrease as payments against the principal gradually increase, but at the end of the 30-year span she has to make a one-time balloon payment of $7,000. Because Catherine expects to be earning more money by then, she agrees to this.