Definition
A balloon payment is a large lump-sum payment due at the end of a loan term, often used in mortgages, commercial loans, and seller financing agreements. These payments are significantly larger than the regular monthly installments and are common in short-term or interest-only loans.
Explanation
Balloon payment loans typically have low monthly payments for most of the term, sometimes covering only interest or a portion of the principal. At the end of the loan term, the borrower must make a final, much larger payment to fully pay off the balance.
Common features of balloon payment loans:
- Lower monthly payments during the loan term.
- A final lump-sum payment (the “balloon”) at maturity.
- Often structured as 5, 7, or 10-year loans with the balance due at the end.
- Used in commercial real estate, short-term financing, and seller-financed deals.
Borrowers typically refinance, sell the property, or use savings to cover the balloon payment when it becomes due. However, failure to pay the balloon amount can result in loan default or foreclosure.
Example
A borrower takes out a $300,000 commercial loan with a 7-year term and a balloon payment structure:
- They make low monthly payments based on a 30-year amortization schedule.
- After 7 years, they must pay the remaining balance of $250,000 in full.
- To avoid the large final payment, they may refinance the loan or sell the property.