What’s a balloon payment?

What is a balloon payment?

A balloon payment is a final lump sum payment at the end of a loan term. Leading up to the balloon payment, borrowers make smaller, fixed payments that aren’t fully amortized. In other words, they don’t cover the total amount of principal and interest to pay off by the due date.

Turn data into insights with Excel

Make better decisions backed by data and insights

Learn more

For example, in a 15-year fixed mortgage, the loan term is 15 years, and the amortization period is 15 years. A fixed monthly payment is paid for 15 years, and at end of the term, the principal and interest for the loan is completely paid off. In a balloon mortgage, the term could be five years and have a 15-year amortization period. A consumer makes the same monthly payment for five years, and then pays the remaining principal, or balloon payment, at the end of the term. In cases where consumers project their future earnings to be higher, this may be an appealing option. Consumers initially pay less and can plan for a large payment down the road.

Benefits of a balloon payment

You can use balloon payments for different types of loans, such as auto loans, business loans, and commercial loans. People typically use them for mortgages. In cases where consumers project their future earnings to be higher, this may be an appealing option. Initial interest rates are lower. Consumers can pay less now and save for a future lump sum payment.

For commercial lending to new business owners, business owners can keep their costs low and pay the lump sum when their enterprise is more profitable. For new, young homeowners, they can buy a home sooner, and in the assumption that their income will grow, address the lump sum later. This type of loan is also great for flipping properties; you can turn the property over and pay the balloon payment before it’s due, all while lowering your upfront costs.

Cons of a balloon payment

In the early 2000s, balloon mortgages were popular. Consumers sought after balloon mortgages as an affordable avenue to homeownership. However, in 2007, housing prices plummeted. Balloon loan borrowers couldn’t sell their homes or get new mortgages, resulting in a wave of foreclosures.

The 2008-2009 housing crisis illustrates the primary concern with balloon payments. It’s risky. In the case of a mortgage, if you’re unable to save enough for the payment, refinance, or sell the house, you can risk foreclosure and severely damage your credit. And because of its impact on the housing crisis and its level of risk, this loan is harder to find. Elevated risk also yields higher interest rates, making your final payment higher than a fixed mortgage. And since the initial payments are small, lower equity in your home might make it more challenging to refinance your loan when the term is up.

How to get out of a balloon mortgage

It might feel like you’re stuck with a balloon mortgage, but there are some things you can try to get out from under an upcoming balloon payment.

Sell your property

If your balloon payment date is approaching, you can sell the property and use the proceeds to pay off the loan. If you’re in a seller’s market, this is a great opportunity to pay off the balloon payment and make profit to invest in a new home. Make sure you have enough time to close the property, which typically takes two months, before the balloon payment.

Refinance

If you want to keep your property but don’t have the money to pay the balloon payment, this is your best option. Loan refinancing allows you to apply for a new loan to replace your current one. Requirements for refinancing include:

• A qualifying credit score
• Moderate debt-to-income ratio
• Cash to cover refinancing costs
• Adequate home equity

To determine whether you qualify for refinancing options, contact your lender directly. To learn more, read about mortgage loan refinancing.

Pay it off

The most straightforward option to getting out of a loan is to pay it off. Plan to save enough money to pay off a balloon mortgage before signing an agreement and pay it off at the end of the term.