When a large sum is paid, it is known as a balloon payment. The term ‘Balloon Payment’ is usually associated with mortgage or in some cases, personal loan. This huge sum of money is paid to repay the loan taken by the borrower. Usually, when the tenure of the loan comes to an end, a balloon payment is made.
The borrower enter a contract in which he agrees to make a balloon payment as soon as the tenure of the balloon payment comes to an end. Since, the borrower has to take the effort to make such a large payment, he often receives certain benefits. The monthly payments are usually small and the rate of interest charged by the lender is low.
Who requires balloon loans?
People who generally want some money to invest in a certain product, and are sure that a healthy profit would be earned borrows balloon loans. Or it can be used by someone who is in urgent need of money, but is sure that he will get the money back after a certain period of time. Some people might also borrow it to give a larger down payment on a mortgage to get the advantage of lower interest rate. Later, when the money comes, they repay the balloon loan and enjoy an inexpensive house.
However, since it involves giving and taking a bulk amount, most lenders will ask for a proof or guarantee of return. If you are putting the money in an investment product, you can show the plan and the documents related to the investment as proof.
If you are a borrower of a balloon loan, you would be glad to know that the most lenders agree to convert such a loan into a structured or traditional loan, if you are unable to pay a lumpsum amount at once. It is better to confirm this before you take the loan. There is however a major disadvantage of transforming a balloon loan into a traditional one: the interest rate would considerably higher than the balloon payment.
Although this quite cheap source of finance, there are several risks associated with such a loan. The biggest risk is making the balloon payment i.e. repaying all the money at once. If the source that you rely on doesn’t work, you will have to find another alternative to repay the balloon loans. And if you don’t make the balloon payment on time, you will have to face a difficult time.