There are instances wherein it makes more sense to apply for a loan, particularly for big purchases such as acquiring a car or a property. In this case, you won’t have to shell out a hefty sum upfront because the lender will be the one who will do that for you. What you have to do is to settle the principal amount that you have borrowed, including the interest and other fees that you and the lender agreed upon within a specific time frame. 

There are various payment options for different types of loans and this article focuses on balloon payments, together with all the things that you should know about them.

Balloon Payment in Brief

A balloon payment is comparable to a lump sum payment of a loan that is made towards the end of the loan period. The amount that you have to pay through may be more than what you settle every month. A balloon payment can also be part of either a fixed interest rate structure or a flexible one. 

The good thing about a balloon payment is that with this payment scheme, you may be able to cut down on your interest payment that is usually made every month. You even get to enjoy lower initial payments. However, balloon payments are usually restricted to credit-worthy borrowers, as well as those with a stable income.

How Balloon Payment Is Calculated

There are various ways on how you will be able to compute your payments with the balloon payment scheme, either for a mortgage or a car loan. When it comes to a mortgage payment, you can consider using an online calculator specifically designed for that purpose. In the case of an auto loan, you can use a car loan calculator with balloon payment options to have a good insight into how much you may need to shell out over your loan term. However, if you want to learn how to manually compute for a balloon payment, then you can explore a couple of methods.

  • Method 1: Balloon payment is given, constant payments need to be calculated.

When you know the balloon payment, you can already compute the constant payments that you have to make. In this case, the other variables apart from the balloon payment that you need to know are the interest rate, loan amount, and term, as well as the payment frequency.

  • Method 2: Constant payment is given, balloon payment needs to be calculated.

Conversely, when you know the constant payments that you need to make, you will also be able to manually compute for the balloon payment. Aside from the constant payment, you also need to know the interest rate, loan amount, and term, including the payment frequency.

In both of the methods stated above, you need to understand that there is a linear but inverse relationship between the constant payments and the balloon payment. You can expect that as the constant payments go up, the balloon payment can fall linearly to zero. When the balloon payment is nearly zero, the constant payments that you have to make can already be comparable to a fully amortized loan.

Applications of a Balloon Payment

  • Mortgages

With a balloon mortgage, homebuyers have the chance to finance their home with a low monthly mortgage payment. However, this is usually offered only to home buyers with a high net worth because they tend to have the capital to make a larger down payment. Several homebuyers who go for a balloon payment also tend to avoid paying a large lump sum in cash by opting to refinance into a different mortgage.

  • Auto Loans

Balloon payments are also available for those who want to borrow money to buy a car. Compared to buying a house, the requirement for balloon payments for car loans is less stringent which is why several people consider this option. Just keep in mind that a balloon payment may not be necessarily a more affordable option. It is just that the payments for the loan are spread out differently.

  • Business Loans

Finally, the balloon payment scheme is also available for those who intend to borrow funds to run a business. More often than not, entrepreneurs go for this option for their short-term financing needs, some resort to this kind of payment scheme if they are in the process of waiting for a large payment from a customer, with which the balloon payment can cover a certain financial gap.

Benefits and Drawbacks of a Balloon Payment

Going for a balloon payment scheme proves to have various benefits, but in the same manner, there are certain drawbacks as well. One of the primary benefits that you can garner from this is the low initial payment. Sometimes, you don’t even have to make an initial payment at all. Those who go for a balloon payment scheme also tend to get access to affordable short-term capital. Finally, balloon payments can also help cover financing gaps.

When it comes to the drawbacks of balloon payments, you need to consider that the costs of the loan can be quite higher in the long term. This is particularly true if the loan applied for is interest-only. Balloon payments also pose more risk than traditional loans because of the payment schedule. There is also no guarantee that you will be granted a refinance to switch the debt obligation in the future.

When it comes to getting a loan, consider whether a balloon payment would be a viable option for you. In this case, you need to familiarize yourself with what it is, as well as how it is calculated. You should also understand where and when a balloon payment is applicable for you to have a good insight into its advantages and disadvantages. 

You can also consider comparing it to a fully amortized loan for you to get a good insight into whether a balloon payment will truly be beneficial for you or otherwise. When you do understand what balloon payments are all about, you will be in a better position to make more informed decisions.