What Is a Balloon Payment?
A balloon payment is a large lump-sum payment due at the end of a loan term, much larger than the regular periodic payments made during the loan. The regular payments may cover only interest, or interest plus partial principal, leaving a large remaining balance due at maturity.
How Balloon Loans Work
A balloon mortgage might be structured as a 30-year amortization with a 7-year term. You make payments as if repaying over 30 years, but after 7 years, the remaining balance -- the balloon payment -- is due in full. The borrower must then either refinance, sell the property, or pay the balloon from savings.
Balloon Loan Example
On a $200,000 loan at 5%, amortized over 30 years with a balloon due at year 7: the monthly payment is $1,073.64, the same as a standard 30-year loan. But the remaining balance due as the balloon payment at year 7 is approximately $175,890 -- most of the original loan, since so little principal has been paid down that early in the schedule.
Risks of Balloon Loans
The primary risk is refinancing risk: if your financial situation or market conditions make refinancing difficult at the balloon date, you could lose the property. If rates have risen significantly by maturity, your refinanced rate may be substantially higher than your original rate.
Balloon Loans After the Mortgage Crisis
The CFPB's Qualified Mortgage (QM) rule generally prohibits balloon payments on consumer mortgages originated by larger lenders. Balloon structures remain common in commercial real estate lending but are rare in residential mortgages for primary residences.
Common Balloon Payment Mistakes
Assuming the loan automatically renews. Most balloon loans don't roll over on their own -- when the balloon comes due, you generally need to qualify for a brand-new loan under whatever rates and underwriting standards exist at that time.
Confusing a balloon loan with an ARM. A balloon loan's rate is typically fixed for the entire term with no periodic reset. The risk isn't a rising payment -- it's the single large payment due on a fixed date.