A balloon payment is a lump sum payment that is significantly larger than the monthly payments and paid at the end of a loan’s term. Unlike loans that have a series of fixed payments to pay off the balance of the loan, a loan that includes a balloon payment is made up of lower fixed payments and a final larger payment.
Although loans with balloon payments can be right for some borrowers, they are one of the riskier types of loans available. Before you seek out this option, read on to learn more about balloon payments, their benefits and downsides, and when—and when not—to use them.
What is the role of balloon payments for businesses?
Borrowers can expect a balloon payment to bemany times the amount of the previous payments - sometime even hundreds of times greater. These loans tend to have shorter terms than traditional loans, with the final payment due after a few months or years.
Although the structure of the loan can be suitable for some businesses, balloon loans are riskier because of the final payment. To avoid potential defaults, most lenders will provide theseloans to businessesand consumers that have excellent credit, sufficient savings, and stable incomes.
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What are 4 things borrowers need to know about balloon loan payments?
Because loans with balloon payments can be risky for some businesses, it’s important to understand the characteristics of the loan to decide if it’s the right choice for you.
1. Lenders might not refinance your balloon loan.
For business owners who pay only the minimum payment on their balloon loan until the final payment is due, there is a possibility that they will have negative equity. With negative equity, banks are not likely to refinance the balloon loan unless the borrower can come up with the down payment. If the borrower cannot refinance the balloon loan or pay the full balloon payment, they risk defaulting on the loan.
2. Balloon loans are riskier for commercial real estate investment.
Because of thepayment schedule, these loans can be riskier for investors or businesses that want topurchase a piece of property. With a relatively short term for the loan, balloons should not be used for long-term investments. Anamortizing loan over 15-25 years might be a better option for commercial real estate investment.
3. The price of the loan might be higher in the long run.
The overall cost of the loan can end up costing the borrower more in the end compared toa traditional loandue to closing costs and fees, which the will borrow incur each time the balloon loan is refinanced.
4. The burden at the end can be great.
For business owners who miscalculate or don’t meet their expected income forecast, the final payment can end up being a major issue, not only in the present but in future borrowing opportunities as well.
Can a borrower get out of a balloon loan payment?
If you have taken out a balloon loan and are finding yourself stressed or unable to pay the final payment, you can consider refinancing. You have several refinancing options:
- SBA 504 loan - These loans are used specifically to fund business growth and job creation. Keep in mind, however, that the SBA doesn’t always allow refinances. If you are eligible, a 504 loan can minimize the risk associated with the balloon payment and let you enjoy longer loan terms and pay back the loan with a low fixed interest rate. Refinancing with a 504 loan can save you money and help settle any anxiety that you have about that final balloon payment.
- Adjustable rate mortgage (ARM) - These loans have an adjustable rate and are amortized over 15-25 years. If you think you might need to refinance a balloon loan, this is significantly less work, since you will need to “touch” your loan each time the balloon terms. Not to mention the additional closing cost each time you refinance the loan. With an ARM, the rate adjusts periodically based on market conditions. These are also a good first option to finance commercial real estate and commercial investment properties.
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Interested in learning about how to finance your next business endeavor?Give us a calland we would be happy to help.
FAQs
The most significant risk of a balloon mortgage is foreclosure if the borrower can't make the balloon payment at the end of the term. Foreclosure can result in the loss of the home, emotional distress, and impact the borrower's credit negatively, generally for seven years.
What is the major problem with balloon payments? ›
The most significant risk of a balloon mortgage is foreclosure if the borrower can't make the balloon payment at the end of the term. Foreclosure can result in the loss of the home, emotional distress, and impact the borrower's credit negatively, generally for seven years.
What are the risks of a balloon payment? ›
But having a loan with a giant balloon payment of most or all of the principal also has clear disadvantages. Defaulting on the loan if the borrower cannot convince their current lender or another entity to finance the balloon payment and cannot raise the funds to pay off the principal balance.
What are the benefits of a balloon payment? ›
The purpose of a balloon is to make your monthly payments more affordable, taking pressure off your budget.
What are the drawbacks of a balloon loan? ›
A balloon mortgage has risks for lenders because the final payment is such a large amount. The odds are greater that the borrower won't be able to make it and that the lender will have to foreclose on the property.
What is the balloon risk? ›
Balloon risk refers to a situation where a large payment is due at the end of a loan term, often much larger than the regular monthly payments.
What are the issues with balloons? ›
The problem with balloons
Balloons end up in our waterways, oceans and parklands, causing significant damage to our environment and harming wildlife in many ways. Balloons break down into small pieces of brightly coloured plastic that can look like food and are often ingested by wildlife.
What are the dangers of ballooning? ›
Accidents are increasingly rare, but they do happen. Data from 2022 provided by the National Transportation Safety Board shows 775 hot air balloon accidents on record in the United States since 1964, total. Only 70 involved fatalities.
What happens if you can't pay a balloon payment? ›
If you can't pay it, you can't keep the car. You might never own the car - If you want to keep the car, you'll need to find the money to make the balloon payment – you could do this through savings, a personal loan, or even refinance using a HP product.
Why do people avoid balloon mortgages? ›
Because they are riskier products, balloon mortgages tend to have higher interest rates than traditional fixed- or adjustable-rate mortgages (ARMs). However, the interest rate on a balloon mortgage might be lower than the rates on other options at first, and you might not have to pay interest at all initially.
A balloon payment is a lump sum payment that is significantly larger than the monthly payments and paid at the end of a loan's term. Unlike loans that have a series of fixed payments to pay off the balance of the loan, a loan that includes a balloon payment is made up of lower fixed payments and a final larger payment.
Are balloon payments a good idea? ›
Are Balloon Payments a Good Idea for a Car Purchase? A balloon payment may be suitable for borrowers who are in urgent need of a car but are unprepared to deal with a large monthly payment. In such cases, the borrower will probably pay a higher interest rate than is charged on a conventional car loan.
How to take advantage of balloon payments? ›
You can use the extra money on other expenses such as groceries or bills – or to save up for the balloon amount over the life of the loan. But keep in mind you will need to make a larger lump sum repayment at the end of the loan term – and you will pay interest on the balloon payment over the loan term.
What are the negatives of balloons? ›
Sea turtles and other marine animals can often confuse burst balloons floating in the water for jellyfish. Once ingested, the plastic can block their digestive tract, leading to starvation. Additionally, as a study published in the Journal of Hazardous Materials notes, latex balloons are not biodegradable.
What are the risks associated with a balloon loan? ›
Refinancing risks
With a balloon mortgage, you'll gain little equity — if any — because you aren't paying down the principal. Even if a lender does approve your refinance application, you could get stuck with a high interest rate if you don't have much equity.
What happens when a balloon payment comes due? ›
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.
Is it worth paying a balloon payment? ›
Is it Worth Paying the Balloon Payment? If you like your car and have the cash to hand, it may be best to pay the balloon and own the car. However, If you don't mind paying a monthly payment or want a newer car, handing the car back and finding a new finance deal is always an option.
What happens if you can't afford balloon payment? ›
Depending on your circ*mstances and the agreement, you may be able to either trade in or sell your vehicle if you can't afford the balloon. Remember that you'll only be able to do so if its market value is enough to cover the outstanding balance on your loan.
How do you beat a balloon payment? ›
How to Avoid a Balloon Payment
- Pay the Balloon Payment Before the Loan Matures. Yes, it's obvious, but if you simply pay the balloon payment in advance, you'll technically avoid it — but you'll still be out a hefty amount of cash. ...
- Negotiate With Your Lender. ...
- Refinance the Loan. ...
- Sell the Property. ...
- Default on the Loan.
