Balloon payment is a lump sum payment towards a loan that is significantly higher than regular monthly instalments. This inflated payment size has led to the use of the term ‘balloon’ for them. All types of loan borrowers can opt for this payment. However, it is more common in commercial borrowing, where commercial establishments pay large balloon payments to reduce their loan burden.
Read on to understand why balloon payments are beneficial, the eligibility criteria and risks involved.
A balloon loan is different from an amortised loan. Under an amortised loan, you need to repay the amount by paying equated monthly instalments. However, in case of a balloon loan, you are required to pay a uniform amount throughout loan tenure, and at the end of tenure, you opt for a large payment known as a balloon payment.
These payments are more common in short-term loans of 5 to 10 years. Making a bulk payment towards the end of a short-term loan to close it goes a long way in helping the borrowers.
Any sort of mortgage loan can become a balloon loan. During the initial days of your loan repayment, you pay a fixed payment which may be the interest component only. Towards the end, you repay a chunk of the loan amount, which could basically be the principal component.
Here are some benefits of balloon payments:
Small regular payments in a balloon loan lower the burden on borrowers. Moreover, the cash that they save by paying small amounts can be invested in another sphere to earn handsome returns and further the process of capital accumulation.
In case of a balloon loan, borrowers get additional time to manage their loans. As borrowers know the exact bulk payment that they need to make towards the end of loan tenure, they can start investing some amount which will create wealth and help them pay off loans more easily.
Balloon payments are generally made for short-term loans. It is ideal for those who are expecting a lump sum amount after a specific time period, like a seasonal worker who may receive a hefty amount at the end of the business season. He/she can opt for a loan and use the lump sum amount as a balloon payment.
Balloon loans can be quite a risky venture for lenders. Therefore, they have put stringent conditions that you must fulfil before opting for balloon payments:
Let’s consider a balloon payment example that will help in understanding this concept more easily:
Suppose a company is aggressively working on developing a new product. However, research and development will entail huge investments. In this scenario, a balloon loan can be an ideal solution.
As the initial payments will be small, the business will not get burdened by repayment schedules during the development years and early operational years. However, when the product gets good business in later years, it will generate enough profits, a part of which can be used to make a balloon payment and close off the loan.
This is how balloon payments help a business manage its finances without getting overburdened and remove the threat of default. Moreover, many financial institutions allow borrowers to modify the repayment conditions to suit their business needs.
Some of the limitations or cons of a balloon payment are as follows:
Some important points related to balloon payment mortgages are as follows:
A balloon payment is an efficient financial tool that helps borrowers lower the burden imposed by loans by paying a bulk amount towards the end. This is beneficial for individuals or corporates who are expecting significant cash flows at a later stage. Individuals should make sure to plan their future finances efficiently before opting for a balloon loan.
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Ans: There are several options that you can exercise to finance balloon payments. This includes selling an underlying asset equivalent to the payment amount, refinancing the loan with fresh repayment terms or transferring it to another lender altogether.
Ans: The effectiveness of a balloon payment depends on your prevailing financial situation. If you are expecting sufficient cash flows after a certain time period, you can opt for these loans. However, if you are not confident about making that bulk payment, you can try a traditional loan.
Ans: In case of traditional loans, the APR or financing charges will be lower than in balloon loans. It is because the latter is riskier for lenders. Moreover, in balloon loans, borrowers pay lesser amounts in monthly instalments as compared to a traditional loan.
Ans: A deposit payment is a lump sum amount that a borrower pays to the lender after the initiation of a home loan or mortgage loan. On the other hand, a balloon payment is a bulk payment paid to the lender at the end of the repayment tenure.
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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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