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What is a Balloon Loan?

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  • Written By: N. Madison
  • Edited By: Bronwyn Harris
  • Last Modified Date: 08 October 2014
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A balloon loan is a type of short-term mortgage. The balloon loan is often compared to the fixed-rate mortgage, as it shares some of its features. For example, a balloon loan offers the borrower a level payment amount over the term of the loan. However, unlike fixed-rate loans, balloon mortgages don’t amortize during the original term. Instead, this type of loan may have one of many maturity types.

When most borrowers take on mortgages, they obtain loans that will be fully repaid over a set amount of time. This length of time is referred to as the loan term. Balloon loans do have set loan terms, just like other types of mortgages. However, the monthly payments the borrower makes are not sufficient to repay the loan. As such, the borrower ends up owing a lump-sum payment, consisting of the remaining principle, at the end of the loan term.

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Often, mortgage borrowers take on loans that last for 10, 15, 20, or even 30 years. Once the borrower makes his final monthly installment payment, he or she is usually cleared of the mortgage debt. Balloon loans often extend for about five to seven years, though term lengths do vary, and the balance of the mortgage loan is due at the end of the term; the debt is not cleared with a final installment payment. In the mortgage world, the end of the loan term is called maturity. Some people view the balloon loan as a poor choice because the borrower must be disciplined enough to plan for a large-sum payment at maturity.

While the disadvantage of having to come up with a large sum of money at the end of a rather short loan term is obvious, there are advantages to securing a balloon loan. One major advantage is that balloon loans often carry low interest payments, allowing the borrower to hold on to more cash over the loan term. The borrower can use the cash as she sees fit, perhaps even investing it in the hopes of earning more than what is required to repay the loan.

A balloon loan is not always forever. Often, these loans offer the borrower a conditional right to refinance into a new loan. This may save some borrowers who predict having difficulty coming up with a lump-sum payment. However, such borrowers may end up paying more over the length of the refinanced loan. This depends on a variety of factors, including the interest rate of both loans and any applicable penalties.

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Crispety
Post 4

I think if you go to Bankrate you should be able to calculate a loan and decide if a balloon payment loan is best for you.

The good thing about a balloon payment loan is that you can refinance a balloon loan and not have to pay the full balloon amount at once.

This will extend your loan payments and probably offer you a higher interest rate, but you always have that option with a balloon loan payment.

I think if I were a real estate investor, I would go with a five year adjustable rate mortgage. Here the first five years of the loan are at a fixed rate and then the subsequent years adjust to a variable rate.

While the payments will be much higher after the payments reset, you may not necessarily need to refinance like you would with a balloon mortgage because you only have to have a few hundred dollars a month to pay not payoff the entire loan.

Also, refinancing a balloon mortgage will cost you money so if you plan on paying off the property quickly or plan on selling within the next few years an ARM loan might be better than a balloon mortgage loan.

suntan12
Post 3

My mother-in-law had a balloon auto loan and instead of purchasing the car, she traded it in for something better.

Usually balloon loan payments on cars are made for luxury vehicles. You normally do not see this type of financing on a $20,000 car.

I know that a lot of real estate investors look at a balloon loan amortization calculators in order to determine if it is worth the risk.

Usually real estate investors may seek out this type of loan because the initial mortgage payments are much lower than with a conventional thirty year fixed rate mortgage.

They may also decide to rent out the property for a few years and then sell it when the market turns and never have to worry about the balloon payment or they may opt to flip the home for a profit within the first year of owning it.

Both scenarios are difficult to achieve in this real estate market, but in a regular real estate market both strategies would yield good results as long as nothing went wrong with the property.

Problems like mold or natural disasters can change the circumstances for the investor.

cafe41
Post 2

Anon69861-That is a really good question. I would imagine that you could sell the vehicle provided that the entire balance of the loan is satisfied.

If there should be a shortfall because you sold the car for less than what is borrowed then you will would be responsible for the difference.

Since cars depreciate almost 30% when they are driven off the lot, chances are you will run into this problem.

The best thing to do is to get a credit union loan for the difference of what you sold the car for and what you still owe, because you will still be legally responsible for that balance.

Balloon auto loans are popular, if you happen to go back to the dealer and want to get a different car, the dealer might work with you on the remaining balance, but if you sell the car on your own you would have to come up with the difference.

anon69861
Post 1

If you bought your car on balloon instalments, what will happen if you want to sell it before the balloon term?

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