Balloon Payments

What are Balloon Payments?

When part repayment of principal loan such as mortgage loan, commercial loan, etc is agreed to be made at the end of the loan period or at the maturity where the total outflow is higher than the approx amount payable on the monthly basis since it does not fully amortize over the term of the loan due to its large amount then it is known as balloon payment.

Example of Balloon Payment Calculations

In this Balloon Payment calculation example, let’s say Mr. Z takes out a balloon mortgageA Balloon MortgageThe Balloon Mortgage calculator computes the amount of balloon balance due at the end of the loan term. It is similar to the outstanding balance formula for a mortgage loan. PV x (1+r)n – P x [(1+r)n – 1 / r].read more of $417000 which is to be paid in two years. What happens in the normal mortgage scenario that the borrower will pay a series of equal installments which will consist of some principal amount and some interest amount so that by the end the borrower has paid the entire loan along with the interest.

However, in case of the balloon payment calculation, the monthly payment will be very low and will consist of a very small amount of principal repayment and at end of the tenure, the borrower will pay a huge amount so that all his dues along with interest gets cleared. Prepare the payment schedule of Mr. Z considering the interest rate to be 2 % and consider the 1st repayment date to be 1st October 2015. The installment which will be paid every month will be $ 1500 inclusive of interest.

Balloon payment calculation schedule for the loan taken by Mr. Z of $ 417000 for two years at the rate of 2 % is as follows:

Balloon Payments Example

In the above schedule, we can see that a huge payment of installment of $ 398805.13 has been made, and in the end, the liability comes to zero. Moreover, the principal component in installment apart from the last one is coming very minimal.

Pros

  • It comes with lower interest rates, so one has to make small monthly payments.
  • A good option for the person having cash crunch but are expecting inflows in the near future.
  • One may qualify for a bigger amount of loans than they do in the normal loans.

Cons

Important Points to be Considered While Taking Balloon Payments

Conclusion

A balloon payment is a type of loan in which small installments are paid during the period of the loan and a final big repayment is done at the end.

This final payment because of its large size is called a balloon payment.

These loans are generally for a short term period and interests are being paid during the loan period and final repayment is done for the outstanding principal.

These are often seen in the mortgage market, the reason being an advantage of lesser initial payment.

The balloon loan might look attractive with lesser initial payment but creates a huge obligation at the end. If the fund is not managed efficiently one will be in big trouble for paying the final payment. The borrower has to check with his needs whether the balloon loan is right as per his needs or not. One who lacks planning and management is not suggested to opt for this loan.

At the same time, the lender is supposed to deeply investigate the borrower’s ability to repay which is also termed as ATR. They must see their probable cash flows and their future commitments which will help them in judging their ability to repay the huge amount at the end.

Recommended Articles

This has been a guide to what are Balloon Payments and its definition. Here we discuss the example of Balloon Payment calculation along with its Advantages and Disadvantages. You can learn more about Corporate Finance from the following articles –

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