A balloon loan ends up with a large payout due at the end of the period stipulated in the contract. Such a loan intentionally structures the first payments so that they are very affordable, while the last payment is considerably larger.  A balloon loan can be a commercial loan, a mortgage, or any other amortized loan. From a certain perspective, it is similar to a bullet refund.

Balloon payments tend to be more common in commercial loans than in consumer loans, since the average owner is typically looking for small interest rates and cannot afford to make a big payment at the end of a loan period.

Terminating a balloon loan

A borrower has a few ways to terminate their balloon loan. In addition to paying off the money, a borrower may also:

• Refinance the loan. Many lenders are willing to work with borrowers and reuse the debt in another loan vehicle or to change the terms of the original contract.
• Sell the underlying asset. Dealing with a balloon payment related to the purchase of an asset can be done if the borrower sells their holding in order to avoid defaulting.
• Pay the money in advance. Even if it is not an obligation, a borrower may want to pay off part of the debt in advance. Any extra payment besides the monthly interest will be applied to the main balance. Just make sure to check with your lender if there are no penalties or prepayment fees.
• Negotiate an extension. An extension is somehow similar to refinancing, modifying the terms of the previous loan. However, instead of getting a new offer, an extension will just push back a bit the moment of payment. The payment terms will likely remain the same, but the deadlines will be different.

Advantages of balloon loans

According to respected mortgage banks offering Colorado home loans, the most significant advantage of a balloon loan is the low payment requirements, at least up until the final payment, which makes it a very good option for individuals who do not have a great financial situation at the moment of getting the loan, but who have the certitude that things will improve for them soon enough.  In other words, as the borrower’s career progresses and their salary increases, they will become able to deal with the balloon payment, at the end of the loan.

In the case of a balloon loan, the underwriting process is also shorter compared to other loans. That`s why there are typically lower transaction or administrative fees in securing the loan. Also, the borrower is not required to submit so much documentation, since balloon mortgages do not necessarily require an evaluation of the house as part of the closing of the loan.

Risks related to a balloon loan

• Failing to pay off the loan, if the borrower is not able to convince their lender (or another financial entity!) to finance their balloon payment – and cannot get the money from other sources either.
• If the value of the property has decreased, there is a risk that it may not be sold at a price high enough to reimburse the balloon payment and terminate the loan.
• In case of requesting a refinancing, it could only be possible with a higher interest rate.