Balloon Payments Defined

Balloon payments are larger, lump sum payments made when loan terms are ending. A balloon payment is greater than the preceding installments and pays off the entire loan. It usually has a due date that falls earlier in the month than the regular installment's monthly due date. Balloon payments can apply to mortgages, auto loans and even personal loans.

The following is an example of how a balloon payment works: Suppose an individual took out a $150,000 loan amortized for 15 years, but the balance had to be paid off in 5 years. In other words, the buyer would be making payments according to the 15-year plan. However, the entire balance of the loan would actually be due in 5, rather than 15, years. This would create an exceedingly large amount (far more than the regular installments) due towards the end of the loan term.

The purpose of a balloon payment is to pay off a loan. Hence, there are some advantages to balloon loans. Balloon loans tend to have lower interest rates. Therefore, they require lower monthly payments before the last balloon payment than certain other kinds of loans do. Another situation in which a balloon loan makes sense is if an individual expects to sell a property before the balloon payment is due.