A balloon loan is a type of financing where the monthly payments are calculated based on a long-term amortization schedule (e.g., 30 years), but the entire remaining balance is due as a lump sum payment after a much shorter period (e.g., 5 or 7 years).
This structure allows for lower monthly payments compared to a fully amortizing loan of the same term length. However, it carries the risk of needing to pay off a large amount at the end of the term, usually by refinancing or selling the asset.
How It Works
- Monthly Payments: Calculated as if the loan were to be paid off over the full amortization term (e.g., 30 years).
- Balloon Payment: The remaining principal balance at the end of the balloon term (e.g., year 5).
Common Uses
Balloon loans are common in commercial real estate, some residential mortgages (like 5/25 or 7/23 loans), and auto financing. They are ideal for borrowers who expect to sell the property or refinance before the balloon payment is due.