A balloon payment is a lump sum paid at the end of a loan's term that is significantly larger than all the payments made before it. Balloon loans allow borrowers to have lower payments at the beginning of a loan in exchange for a larger (balloon) payment at the end of the loan's term. In general, these loans are better for borrowers who have excellent credit and a substantial income.

What is a balloon payment?

Balloon payments are generally defined as loan payments toward a balloon loan that are at least twice as large as regular payments.

By requiring one large lump sum payment at the end of a loan, balloon loans allow borrowers to keep their monthly loan repayments low at the beginning of the loan.

Balloon loans usually have shorter terms than traditional installment loans, with the balloon payment typically due after a few months or years.

Balloon payment structures are most commonly used for business loans, though they are also available on auto loans and mortgages.

Despite their reduced initial payments, balloon loans are riskier than traditional installment loans because of the large payment due at the end. As such, most lenders will only provide these loans to consumers and businesses with excellent credit, sufficient cash on hand and stable income streams.

A handful of states have banned consumer balloon payment mortgages and placed significant restrictions on balloon auto loans.

For auto loans and mortgages, borrowers must usually make a large down payment to qualify.

Examples of balloon payments

Balloon payments are most commonly used with the following types of loans, though these products may look different than their traditional counterparts.

Mortgages

Balloon mortgages allow qualified homebuyers to finance their homes with low monthly mortgage payments at first.

A common example of a balloon mortgage is the interest-only home loan, which enables homeowners to defer paying down the principal for three to 10 years and instead make solely interest payments.

Interest-only and other balloon mortgages are typically used by high-net-worth homebuyers who have high credit scores and enough capital to afford to pay down a large principal on a normal amortization schedule.

Most borrowers of balloon mortgages don't actually make the balloon payment when the low payment period ends. Rather, to avoid paying the large lump sum in cash, it's common to refinance into a different mortgage or sell the house first.

Business loans

Businesses often use balloon loans for short-term financing needs or for commercial real estate purchases.

For a business that needs working capital and is waiting for a large payment from a customer, a balloon loan can be an affordable way to provide gap financing. Balloon loans can also be helpful for companies looking to move into a new office before selling the old one, as the deferred payment schedule allows time to sell the old property.

Balloon loans pose the same risks to businesses as to consumers. For a business without a guaranteed income stream, it can be dangerous to take on a liability that demands a large lump sum payment.

Although refinancing is an option to get out of a balloon loan, there's no promise that a lender will grant you a new loan. If your revenue drops off or your industry takes a hit, there's a good chance you could be stuck with a large outstanding debt.

Auto loans

Balloon payments are not as common for auto loans as they are for mortgages or business loans. However, lending restrictions are less stringent in the auto loan industry, so it's a bit easier for consumers to take out this kind of loan.

Many borrowers enter into balloon car loans thinking that they'll see an increase in their income by the time the payment is due, often leaving themselves unable to pay down the lump sum.

While balloon car loans help secure lower monthly payments, consumers tend to take out these loans for the wrong reason.

It's important to remember that balloon loans aren't actually more affordable — they only spread the total cost out in a different way. If there's no absolute guarantee that your income will substantially rise, you should choose a loan that you can finance fully on your current income.

Pros and cons of balloon payments

Frequently asked questions