A balloon payment is a larger-than-usual one-time payment at the end of the loan term. If you have a mortgage with a balloon payment, your payments may be lower in the years before the balloon payment comes due, but you could owe a big amount at the end of the loan.
The payment on a balloon mortgage loan is typically due on the loan maturity date — in other words, the date the mortgage becomes due in full. So, in the case of a five-year balloon mortgage, a balloon payment is due at the end of the five-year term and pays off the remaining loan balance.
What Happens When the Balloon Payment Is Due? When your balloon payment is due, you have two choices to pay it off: You can take out another mortgage for the amount of the balloon payment or you can sell your home and use the proceeds to pay it off.
Balloon payments allow borrowers to reduce that fixed payment amount in exchange for making a larger payment at the end of the loan's term. In general, these loans are good for borrowers who have excellent credit and a substantial income.
You'll pay only interest on some balloon mortgages for the repayment period. This means borrowers pay only the monthly interest on the loan. The entire original principal balance is due at the end. This is most common in commercial real estate but isn't unheard of in the residential mortgage market.
Pay off the loan.
For a loan with a balloon payment at maturity (this happens when the amortization period extends beyond the maturity of the loan, so the loan doesn't fully amortize over its term), the final payment may be much larger than what you've been paying each month.
It should not be used as an end to a means to buy a car that you can't afford to maintain. “Balloon payment deals require discipline. If a buyer is not financially savvy enough to manage cash flow and continue to save during the finance term, then a balloon deal is probably not the best option for that person.”
If your car is worth more than the balloon payment at the end of the contract, then paying this could leave you better-off in the long run, even if you don't want to keep the car. You could sell the car immediately, leaving you with a surplus amount.
According to the Motor Finance Corporation, even though the balloon payment is used to reduce your monthly instalments, it remains part of your finance agreement. This means that, when you ask for a settlement amount on your vehicle, the balloon amount is included in the calculation of the settlement amount.
Balloon financing means a portion of the selling price – the balloon – is payable only at the end of the loan agreement. This reduces the monthly instalments but the balloon payment still lies in wait. The balloon can be as much as 20% or 35% of the selling price.
You can arrange that your car's trade-in value is used to cover its balloon. If your trade-in doesn't cover the balloon in full, you will have to settle it in full.
Can you refinance a balloon mortgage? Thankfully, you can. And unless you're simply rolling in dough, you may be forced to refinance. A balloon mortgage is a home loan with a short term, often 5 - 7 years, after which the rest of the loan is due in one large payment, called a balloon payment.
If you want to reduce or eliminate your balloon amount, make larger payments consistently. Although a higher payment eliminates the benefit of a balloon mortgage, you will pay off the loan early. The amount you will need to increase your payment is based on the principal, interest and term.
Cons of a balloon payment
The loan provider may not approve refinancing of your balloon payment if you can't pay it when the time comes. Not being able to afford a balloon payment may lead to a cycle of debt because you will need to refinance it.
There also are drawbacks to balloon payment promissory notes that should be considered: Unsecured loans with balloon payments usually have a higher interest rate than conventional loans. Paying that large balloon payment at the end of the loan may be financially difficult for your business.
Example of a Balloon Loan
Let's say a person takes out a $200,000 mortgage with a seven-year term and a 4.5% interest rate. Their monthly payment for seven years is $1,013. At the end of the seven-year term, they owe a $175,066 balloon payment.
Balloon payment schedule
A 30/5 structure means the lender calculates your monthly payments as if you'll be repaying the loan for 30 years, but you actually only make those payments for five years. At the end of the five-year (60-month) term, you'll repay the remaining principal, or $260,534.53, as a lump sum.
If you owe a loan balance at maturity and become delinquent on payments, the bank can send your account to collections. The bank will charge late fees on the missed payments. The interest will continue to accrue on the balance you owe. To avoid additional fees and finance charges, you should stay current on payments.
If you own a balance past the maturity date, your lender will charge fees on the payments you missed. And the interest will continue to accumulate on the remaining amount.
If you fail to pay your loan at maturity without making arrangements to refinance or extend the maturity date, the lender will declare a default. It will send a demand letter requiring you to pay the loan in full.
Once your balloon mortgage comes due, your lender expects a total payoff. If you do not have the funds to pay your balance, your loan is in default and the lender can foreclose.
In a balloon mortgage, there would be lower monthly payments compared to the traditional loans, plus it incorporates higher risk because of the lump-sum payment. Therefore, balloon mortgages are generally restricted to some of the most creditworthy and income-stable loan borrowers.
If you have an Interest Only mortgage, your monthly payments have been paying the interest but have not reduced your loan balance (unless you have been making overpayments to purposely reduce the balance of your mortgage). This means that at the end of your agreed mortgage term, you need to repay your loan in full.
When your current mortgage term reaches its maturity date, you'll need to renew the outstanding balance for another term. This is a process you'll likely do a number of times until you pay off your mortgage in full. Just before your term expires, your current lender will send you a renewal offer in the mail.