What is a balloon payment?
June 28, 2021, | AtoZ Markets – A balloon payment is a type of installment when the loan term terminates. These loans, such as mortgages or commercial loans, require a borrower to pay a more significant sum of money instead of amortizations. Borrowers pay a very minimal amount monthly until the balloon payment’s due date. Another term for balloon payment is bullet repayment.
More on the balloon payment
Amortization is a typical loan set-up where a borrower pays an equal amount every month until the very last payment. In an amortization, there is a basic schedule that helps calculate a price.
However, in a balloon payment, the variation is a borrower agrees to pay a big lump sum of money or the remaining balance at the end instead of paying a regular monthly fee. Unlike normal amortization, the money is not spread evenly throughout the loan term since the monthly payment is minimal. Somehow, the money that the borrower is supposed to pay monthly moved in the loan termination.
Advantages and disadvantages of balloon payments
Creditors can help borrowers afford a loan now, even if they can’t afford it yet, provided that they are confident that they can afford to pay a significant amount of money in the future.
However, the downside to a balloon payment, specifically in mortgages, is a decline in the housing market. If the value of a house drops, the chances of borrowers having positive home equity declines as well. If they plan to sell the house in the future, the price would be much lower than what they paid in the loan. It leaves them forced to drop their loans regardless of their wages.
The confusion between balloon payments and adjustable-rate mortgages
There is always confusion with the difference between balloon payments and adjustable-rate mortgages. Adjustable-rate mortgages or ARM have introductory rates for a while, ranging from one to five years. After that period, there will be an interest rate reset. It may continue until the loan is exhausted. The difference between an ARM from balloon payment is that borrowers have less hassle since they don’t need to reapply for a new loan.
Examples of a balloon payment
Ruffa wants to buy a house, but she could not yet afford it as of the moment and can only shell out $500 a month for a place or rent. A creditor granted her a 30-year mortgage plan with a customized payment of $500 a month but with the condition that she should pay a hefty price amounting to thousands of dollars at the end of the loan. She agrees to this since she is confident that she can save or earn more in the future.
Are you qualified to apply?
Creditors need to ensure that you are highly capable of repaying before applying for any mortgage loan. We call this Regulation Z of the Truth in Lending Act, where they set lenders’ criteria before saying no to borrowers. Most applicants cannot generate money to pay for a considerable amount, such as a balloon payment, so some lenders do not include this when they do evaluations.