Balloon Loans in Home Loans
What is a balloon loan?
A balloon loan is a loan that comes with:
a large final payment
multiple regular large payments at the end of its term or,
periodic large payments during the term of the loan
Balloon loans are usually short term and usually only a small portion of the principal will be paid by the end period of the loan term. They look something like this, a $400,000 loan is to be amortized over 30 years but due in 5 years. The borrower will make payments like they are on a 30-year amortized payment plan, but the loan will be due in 5 years. The amortized payments will pay for mostly interest and a small portion of the principle, the balloon payment is likely to be close to the principal. The payments for that kind of loan would be financially hard for the average person. Interest only loans and adjustable rate mortgage loans are types of balloon loans.
It is rare that the average person can afford to make the final balloon payment. They use a balloon loan in anticipation that the asset (usually a home) will increase in value before the balloon payment is due. If it does increase in value they can sell the asset (home) and be able to pay off the loan and have money remaining. Another popular option is to apply for refinancing to pay off the balloon payment.