Balloon payments are a feature found in certain types of loans, and they differ from traditional amortizing loans where you pay both principal and interest over the loan term. Here's what to expect with balloon payments:
1. **Lower Monthly Payments:** Loans with balloon payments typically have lower monthly payments compared to fully amortizing loans. This is because you're only paying the interest on the loan during the loan's term, not the principal.
2. **Large Lump-Sum Payment:** The defining characteristic of a balloon payment loan is that, at the end of the loan term, you're required to make a substantial lump-sum payment to cover the remaining balance of the loan. This balloon payment can be significantly larger than your previous monthly payments.
3. **Shorter Loan Terms:** Balloon payment loans often have shorter loan terms, such as 5, 7, or 10 years. At the end of this term, you make the balloon payment.
4. **Refinancing or Selling the Asset:** To make the balloon payment, borrowers often need to have a plan in place. Some options include refinancing the loan before the balloon payment is due or selling the asset (such as a car or property) to cover the balloon amount.
5. **Risk and Considerations:** Balloon payment loans carry certain risks. If you can't make the balloon payment when it's due, you might face financial hardship, including potential default and repossession of the financed asset.
6. **Interest-Only Period:** In some cases, balloon payment loans have an initial period where you only pay interest, followed by the balloon payment. This can lead to lower initial payments but a large final payment.
Balloon payment loans are most common in commercial real estate and some types of auto loans. Borrowers should carefully consider their ability to make the balloon payment and have a clear plan for doing so when taking out such loans. It's essential to fully understand the terms and risks associated with balloon payment loans and, if possible, consult with a financial advisor before entering into such an agreement.