• 
  What Is a Balloon Payment?
• How It Works
• Examples
• Avoiding a Balloon Payment
• Advantages
• Disadvantages
• Balloon Payment FAQs
• The Bottom Line

Balloon Payment: What It Is, How It Works, Examples, Pros and Cons

By 

Carol M. Kopp

Updated June 29, 2023

Reviewed by Eric Estevez

What Is a Balloon Payment?

A balloon payment is the final amount due on a loan that is structured as a series of small monthly payments followed by a single much larger sum at the end of the loan period. The early payments may be all or almost all payments of interest owed on the loan, with the balloon payment being the principal of the loan. This type of loan is known as a balloon loan.

The balloon home mortgage loan became common in the years before the 2007-2008 financial crisis. It allowed people eager to buy a home to obtain a mortgage payment that they could afford, at least in the early years.

The balloon loan did not disappear with the financial crisis but is now more often used for business loans. A project can be financed with a loan that allows for minimal payments early on, with the balloon payment due only when the project is earning a return on the investment.

The balloon payment is similar to a bullet repayment.

Key Takeaways

• A balloon payment is a type of loan structured so that the last payment is far larger than prior payments.
• Balloon payments are an option for home mortgages, auto loans, and business loans.
• Borrowers have lower initial monthly payments under a balloon loan.
• The interest rate is usually higher for a balloon loan, and only borrowers with high creditworthiness are considered.
• The balloon payment may be a weighted payment amount or, under an interest-only payment plan, be the full balance of the principal due.

Understanding Balloon Payments

As the term “balloon” suggests, the final payment on this type of loan is significantly large.

In recent years, balloon payments have been more common in commercial lending than in consumer lending. It allows a commercial lender to keep short-term costs lower and take care of the balloon payment with future earnings.

The same logic is used by individual homebuyers, but the risks are greater. Homebuyers are keeping their short-term costs low while assuming that their incomes will be far greater when the balloon payment comes due, that they will be able to refinance their mortgage before it is due, or that they can sell the house and pay off the entire mortgage before the balloon payment comes due.

That strategy failed in the 2008-2009 financial crisis, when homeowners who financed their purchases with balloon mortgages found it impossible to sell their homes at a price high enough to pay off the amount they had borrowed.

Fast Fact

Balloon payments are often packaged into two-step mortgages. In this financing structure, a borrower receives an introductory and often lower interest rate at the start of their loan. Then, the loan shifts to a higher interest rate after an initial borrowing period.

Balloon Payment Examples

A balloon debt structure can be implemented for any type of debt. It’s most commonly used in mortgages, auto loans, and business loans.

Mortgage

The balloon mortgage is rarely used for traditional 15-year or 30-year mortgages since lenders don’t want to wait that long to get their money back. For balloon mortgages, lenders prefer a five-year to ten-year term.

Interest-only balloon mortgages are available primarily to high-net-worth individuals who can afford large down payments. They are often taken with the intention of refinancing before the balloon payment is due.

Balloon Loan vs. ARM

A balloon loan is sometimes confused with an adjustable-rate mortgage (ARM). With an ARM, the borrower receives an introductory rate for a set amount of time, usually for one to five years. The interest rate resets at that point and might continue to reset periodically until the loan has been fully repaid.

The incentive is a very low-interest rate at the beginning, compared to the fixed-rate mortgage rate. The downside is the potential for a substantially higher rate down the road.

An ARM adjusts automatically, unlike balloon loans.

Calculate Your Monthly Payment

Your monthly mortgage payment will depend on your home price, down payment, loan term, property taxes, homeowners insurance, and interest rate on the loan (which is highly dependent on your credit score). Use the inputs below to get a sense of what your monthly mortgage payment could end up being.Enter Home Price

$Enter Down Payment

$

%Select Loan Term

30 years20 years15 years10 yearsEnter APROr Use Credit Score For Estimate

%

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Your Credit Score760-850700-759680-699660-679640-659620-639

+ More Options

Monthly Payment

$2,649.04/monthfor 30 yearsMonthly Payment$2,649.05

Principal & Interest

$2,264.38

Property Taxes

$256.67

Homeowners Insurance

$128.00

Mortgage Size$352,000.00

Mortgage Interest*$463,176.16

Total Mortgage Paid*$815,176.16

*Assuming a fixed interest rate. A variable rate could give you a lower upfront rate. To understand more click here.Expand

Auto Loan

Balloon loans are not as common when used as auto loans. However, this structure works especially well for individuals who have an urgent need to secure a vehicle but can’t immediately afford high monthly payments.

As lending restrictions are often not as stringent in the auto loan industry, it is often easier for a borrower to secure this type of loan. Lenders are usually comfortable with the standard car loan term of up to six years.

Business Loan

It is usually easier for a business to secure a balloon loan if the business has a proven financial history and favorable credit record. An established business can be in a better position than an individual wage-earner to raise sufficient money to pay off the balloon payment.

For this reason, lenders often consider businesses less risky than individual consumers for business loans.

Balloon payments can be strategically used by a business to finance short-term needs. The business may draw on a balloon loan with no intention of holding the debt to the end of the term. Instead, the company can use the money to repay the loan in full before the end of the loan term.

Options for Avoiding a Balloon Payment

A borrower has a couple of ways to get rid of a looming payment. In addition to extinguishing the debt by paying off the balloon payment, a borrower can:

• Refinance the loan. A lender may be willing to work with a borrower to repurpose the debt into a different loan vehicle or modify the terms of the original agreement.
• Sell the underlying asset. If the balloon payment is due to the purchase of an asset, a borrower may be forced to liquidate the holding to avoid defaulting on the loan.
• Pay principal upfront. Though not required, a borrower may be able to pay a portion of the debt early. Any payment made more than the interest assessment will be applied to the principal bala