What are Balloon Payments?

Balloon payments can offer financial flexibility but also come with serious risks.

Consumer loans are often amortized, meaning repayment occurs via fixed installments. Balloon loans, however, feature a final payment that’s significantly larger than those preceding it.

While balloon loans are less common and more risky than amortized loans, they can offer valuable financial flexibility in certain situations. In this article, we explain how balloon payments work, and explore the potential advantages and disadvantages of balloon payment loans.

Key Takeaways:

• A balloon payment is a single payment due at the end of a loan term that significantly exceeds the amounts owed during the life of the loan.
• Balloon loans are less common than amortizing loans for consumers, but certain auto loans and mortgages come with balloon payments.
• The risks of balloon payments are substantial, since individuals may be ill-prepared to make such a large payment.
• In certain situations, however, the financial flexibility offered by balloon loans can be beneficial.
• To avoid a balloon payment, individuals can refinance their loans with an amortizing loan or sell the underlying asset to make the final payment.

How do balloon payments work?

A traditional amortized or installment loan is structured so the borrower pays off both the principal and interest in regular, consistent amounts. That means the borrower will be able to pay off the entire loan in a known time frame with no surprises.

Loans with a balloon payment are different. While borrowers typically still need to make payments throughout the life of the loan, they’ll also owe a large, one-time payment at the end of the process.

Instead of fixed monthly borrowing payments that gradually eliminate debts and establish credit, balloon loans are paid off with large single payments when a loan has reached maturity.

Depending on the terms of the loan, the size of the balloon payment can differ. Many balloon mortgages are ‘interest only,’ meaning that borrowers pay interest expenses over the life of the loan and repay the entire principal amount at maturity. Other balloon loans may be ‘partially amortizing,’ meaning that borrowers repay some (but not all) of the principal over the life of the loan.

As the name suggests, balloon payments tend to be significantly inflated relative to preceding payments, typically at least twice the amount of a loan's prior regular payments.

Advantages of balloon payments

Loans with a balloon payment can be risky, especially if the borrower is unprepared to make such a large payment. These loans do have some advantages, however, meaning the risk can be worth it in certain situations.

Lower monthly payments

Opting for a loan with a balloon payment can unlock lower monthly payments over the life of the loan. If you are looking to buy a house but can’t afford monthly payments under an amortizing mortgage structure, a balloon mortgage could be one way to minimize your monthly payments while still achieving homeownership.

Windfall planning

Balloon payments can offer more flexible financial planning for individuals who expect to receive a significant windfall. For example, a startup founder who draws a minimal salary but expects to sell her company for millions of dollars in the next few years might benefit from a balloon mortgage. Similarly, an individual waiting for a large payout from a pending lawsuit might wish to push off their largest debt payments to the future.

Benefit from appreciation

Buying an asset with a loan is a form of leverage, which can magnify the gains associated with increases in the asset’s price. Because amortizing loans reduce the amount of principal owed over time, however, these loans also gradually reduce a borrower’s leverage. For individuals who want to maintain high leverage in order to maximize their potential benefit from home price appreciation, an interest-only balloon mortgage might make sense.

Disadvantages of balloon payments

Refinancing may be expensive

Some borrowers with balloon loans plan to ‘roll over’ their loans when the balloon payment comes due by refinancing the amount. By the time this occurs, however, rates may have climbed significantly. With mortgage rates rising to over 6% as of September 2024, refinancing a balloon mortgage has become much more expensive.

Financial planning risks

An amortizing loan makes the financial planning process easier by mandating consistent, fixed payments from borrowers. Because a balloon loan has a single outsized payment, borrowers need to prepare for this with regular savings. For borrowers who struggle with financial planning skills or have a poor history of sticking to a budget, the balloon structure can pose significant risks.

Possibility of depreciation

Just as increased leverage allows individuals to benefit more from rising asset prices, it also magnifies the losses associated with falling prices. While home prices tend to appreciate historically, depreciation is always a possibility.

“The greatest risk with balloon mortgages is that the property goes down in value, rather than appreciating,” said Brian Davis, co-founder of SparkRental.com. “In that case, the borrower often can’t refinance or sell without taking a loss.”

How to avoid balloon payments

Brain Davis advises that most borrowers should avoid balloon payments if possible: “Unless borrowers know for a fact that they will be selling the property within the balloon period, I recommend they avoid balloon mortgages and take out a 15- or 30-year fixed mortgage.”

If you can’t afford the monthly payments on a traditional mortgage, it might be worth holding off on buying a home. While you may have been told that renting is equivalent to throwing your money away, this is not necessarily the case. Homeownership also comes with many unexpected costs, so waiting can be a sound financial decision.

But what if you’ve already taken out a balloon mortgage and have a large payment looming? In this case, there are two main avenues you can pursue to avoid that payment.

Selling your home

While selling your home may not be ideal, especially if you like where you’re living, this is a viable route to pay off your mortgage and thereby eliminate the future balloon payment. In fact, if the price of your home has appreciated, you might benefit even more than you would have with an amortizing mortgage.

Refinancing

Refinancing can allow you to pay off a balloon mortgage without needing to leave your home. To avoid kicking the can down the road, you can refinance your balloon mortgage with a traditional amortizing mortgage. The downsides here involve potentially higher interest rates and ‘resetting the clock’ with a new loan.

The bottom line

Owning a home has long been part of the American Dream. Thanks to lower monthly payments, a balloon mortgage might seem like a viable way to achieve that dream, especially as housing costs grow nationwide.

Unfortunately, the downside risks of balloon mortgages are likely to outweigh any of their potential benefits. Before locking yourself into any financial commitment, always do your research and consult with unbiased experts.

Curious for more info on homeownership? Take a look at our series of articles on home loans.

Key Points:

• Taking out a balloon loan is risky. Individuals should generally stick with the predictability of an amortizing loan.
• Balloon payments are typically at least twice the size of previous payments, and often more.
• For individuals who expect to experience a significant windfall or don’t plan to live in their home long-term, a balloon mortgage can make sense.
• To avoid an upcoming balloon payment, borrowers can either refinance or sell their home.

FAQs

What types of loans typically have balloon payments?

Loans with balloon payments are more common in the corporate and business world, but some consumer loans have balloon payments too. The most common consumer balloon loans are certain types of mortgages and auto loans.

Who is likely to qualify for a balloon payment?

Lenders often set their own requirements for consumer balloon loans, which are less popular than traditional amortizing loans. Typically, responsible lenders prefer balloon loan borrowers to have high incomes, sizable down payments, and a clear plan to make the balloon payment when it comes due.

What happens if I can't pay my balloon payment?

If you’re unable to make your balloon payment, your lender will likely foreclose on the asset that you purchased, such as your house or car. Additionally, your credit history could face serious consequences. If you don’t anticipate being able to make a balloon payment, pursue alternative options prior to the loan’s maturity, such as refinancing or selling the asset.

Can I negotiate a balloon payment?

You might be able to negotiate a balloon payment prior to taking a balloon loan, such as by requesting partial amortization. Once you’ve taken out the loan, however, you are responsible for making the agreed-upon payments. Subsequent negotiation, such as through debt settlement, could have adverse credit consequences.

Can you extend a balloon payment?

While you can’t typically extend a balloon payment, you may be able to refinance your balloon loan in order to ‘roll over’ the debt. This allows you to pay off your existing loan with a new loan, effectively extending the maturity of the debt.

How long is the loan term in a balloon payment?

There is no set loan term in a balloon payment, but balloon loans tend to be shorter than amortizing loans. Balloon mortgages, for instance, may have a maturity of less than seven years.

How to get rid of a balloon payment

To avoid a large balloon payment, you may be able to prepay the loan over time in order to reduce the amount owed at maturity. Always double-check if the lender implements prepayment penalties, however. Alternatively, you can consider refinancing your loan at maturity or selling the underlying asset to make the payment.

G. Brian Davis is a landlord, personal finance writer, and co-founder of SparkRental.com, which provides free video courses and rental investing tools for landlords. He spends most of the year overseas, splitting his time between Abu Dhabi, Europe, and his hometown of Baltimore.