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A loan that is not designed to be fully paid back by the end of the term and requires a balloon payment at maturity.
Balloon loans are primarily used for mortgage or auto loans. In a balloon mortgage, the buyer takes out a loan with a low-interest rate; the payment method used is mostly the same as for a 30-year mortgage. After the end of the term, the balloon payment is to be paid off. The buyer has a few options at this stage: sell the property or apply for a traditional loan with lower interest rates than before. There is a risk that the property might not be worth the amount required or that the interest rates are higher.
A person is looking to buy a house worth $200,000. He takes out a balloon loan with an interest rate of 4.5% per month. The term is decided to be seven years. The person has to make a payment of $1,013 per month for the next seven years. At the end of the term, he paid $85,092, and $175,066 remains. This remaining amount will be called a balloon payment.
Balloon loans are easier for buyers looking for a shorter loan period.
But with all these advantages, balloon payments are also incredibly tricky to deal with. Some of its disadvantages include:
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