To put it simply, a balloon payment is an amount paid at the end of a loan tenure which is a larger amount than the rest of the installments. Loans other than the balloon payment loans have a set of installments of the fixed price which are given out to repay the total loan amount. With a balloon mortgage, the borrowers have the liberty to cut down on the fixed-priced installments by paying a large amount at the end of the loan tenure. For borrowers with substantial income and a good credit score, balloon loans are the best choice.
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Balloon Payment Examples:
Business Loans
In terms of business, the balloon repayment option is chosen for commercial real estate purchases and for financing needs that are short-termed. If your business is waiting for huge capital from a customer, having a balloon mortgage assists in delivering the needed gap financing. Also, if you are planning to shift your office to a new place without selling the old one, a balloon loan comes in handy. A balloon repayment plan gives you time for making a sale on the old site of work.
Mortgages
If you are planning to get a house mortgage, the option of balloon payment might be available. Balloon mortgages allow you to get a property financed with small monthly payments. For instance, if your option is of an interest-only mortgage, your monthly installments will comprise only of the interest amount and not the original capital. This accounts for your monthly payments being less but at the end of the tenure, you will have to repay the original capital borrowed from the lender. This option is good for buyers who have a huge net worth.
Car Loans
In comparison to house and business mortgages, a balloon payment is chosen less for car loans. It is so because the restrictions for lending in this particular industry are not quite stringent thus making it easier for the consumers to get this type of loan. The overall cost is divided differently but it does not mean that balloon mortgage becomes affordable.
Why Should You Get a Balloon Mortgage?
People envisioning a shorter stay at their home should go for balloon payment as the monthly instalments are not huge and the overall cost to be paid becomes less. Also, this kind of mortgage gets repaid in fewer years as compared to conventional loans that take up to 20 to 30 years for repayment.
And professionals whose major portion of income comes as a year-end bonus should also go for a balloon loan. With this bonus, you will be able to repay the home loan quicker by giving a larger sum of money at the end of the year.
Application of Balloon Repayment Plan
Financial management is one aspect where balloon payment can be considered to be an important tool. For instance, a small business is planning to launch a new service or product and the process needs some capital knowing that the product will not generate revenue in the initial years. Having a balloon mortgage will ease the financial burden in the initial phase of the development as the payments will be low then. When the business moves out of the development phase and starts generating revenue, it can repay the balloon mortgage amount at the end of the tenure. Because the instalments can be modified as per the present conditions, it helps in financial management.
Pros of Balloon Payment
1. Almost zero or low initial payments
2. Accessibility to short-term finance
3. Helps in covering financial gaps
Cons of Balloon Payment
If the loan type is interest-only, the overall cost of the loan can turn out to be more in the longer run.
Risk is higher as compared to conventional loans because of the payment schedule.
For switching a debt obligation, you might not get a refinance.
What if you are unable to pay the balloon mortgage?
If a borrower is unable to repay a balloon payment, he/she might have to go for a refinance or selling of an asset to pay off the money. To recover the money, the lender can also foreclose an asset of the borrower.
Important Real Estate Terms You Should Know
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| Common Areas in Apartments | What is Common Areas in Apartments |
| Commencement Certificate | What is Commencement Certificate |
| Carpet Area | What is Carpet Area |
| Brownfield Project | What are Brownfield Project |
| built-up-area | What is built-up-area |
| Debt to Income Ratio | What is Debt to Income Ratio |
| Super Built-up Area | What is Super Built-up Area |
| Annual Statement of Rates | What is Annual Statement of Rates |
Frequently Asked Questions
What are the benefits of balloon loans?
Low initial payments and affordable financing are the benefits of balloon loans.
What is the difference between an amortized loan and a balloon loan?
In amortized loans, the total amount of the monthly installments are divided into two parts where one goes in the repayment of principal amount and the other goes to repay the interest. Whereas in balloon loans, a large sum of money is given at the end of the loan tenure as the monthly installments are of low amount.
How can I reduce my balloon payment?
You can do this by giving additional payments but remember to inform the concerned lender.
Are balloon payments legal?
Yes, balloon payments are legal.
Is a balloon payment a bad idea?
It is not a bad idea but it does come with a substantial risk of paying a large amount at the end of the tenure.
