What is a balloon payment?

A balloon payment is a one-time larger-than-normal payment due at the end of the payoff period for a loan. Typically, the borrower makes smaller payments throughout the life of the loan. Then, when the final payment is due, they make a large final payment to fully pay back the loan. This payment structure is typically used for mortgages, auto loans and business loans.

What you’ll learn:

• Balloon loans are an alternative to traditional loans for things like homes, cars and businesses.

• Balloon loans typically have lower monthly payments than traditional loans. But they may come with higher interest rates and require a single larger-than-usual payment made at the end of a loan term.

• If a borrower can’t make a balloon payment, they may need to refinance their loan or sell what they purchased with the loan.

A balloon loan offers relatively low payments throughout the life of the loan until the final payment is due. At the end of the loan term, a large final payment, known as a balloon payment, is due to pay off the remaining loan balance.

Installment loans may feature balloon payments. They include:

• Mortgages: According to the Consumer Financial Protection Bureau (CFPB), mortgages with balloon payments tend to have shorter loan terms compared to traditional mortgages. The CFPB also cautions that balloon payment mortgages can be risky, and the final payment may be a significant portion of the loan amount. 

• Auto loans: A balloon payment for an auto loan might be up to half the entire loan amount. And the lender might charge a higher annual percentage rate for a balloon loan compared to a traditional auto loan.

• Business loans: Balloon payments tend to be more common in commercial lending than consumer lending. Businesses may use balloon loans to fund short-term financial needs and use future earnings to cover the large final payment.

Eliminating an upcoming balloon payment may not always be an option. But there may be some ways to adjust. Here are a few possible options to explore:  

• Refinance: Refinancing into a new loan could restructure things like the monthly payments, interest rate and loan term. Keep in mind that closing costs may be involved.

• Ask for an extension: If a lender grants an extension, the balloon payment might be due later. Depending on the new agreement, the other terms of the loan could stay the same.

• Pay off some of the principal early: Paying more than the minimum early on could help reduce the loan principal, which in turn could reduce the balloon payment.

There may be some pros and cons of balloon payments to think about before taking on new debt. Before applying for a balloon loan, consider asking these questions:

• Is the APR for the balloon loan higher than the APR for a traditional loan?

• How much will the monthly payments be?

• Are the lower monthly payments worth it if I need to make a balloon payment at the end of the loan?

• Do the monthly payments go toward only the interest or would they cover the interest and principal?

• How much will the balloon payment be?

• When will the balloon payment be due?

• Will I be able to afford the balloon payment? 

• Could I lose my home, car or business if I can’t make the balloon payment?

• What are my options if I can’t afford the balloon payment?

Balloon loans can be an alternative to traditional loans for things like homes, cars and businesses. They’re named for the large one-time payment made at the end of a loan term.

While they could come with lower monthly payments than traditional loans, balloon loans may have higher interest rates. And the balloon payment can also be significantly larger than the loan’s monthly payments.