What is a balloon payment?

A balloon payment doesn’t involve paying for a ride on a hot air balloon. Rather, a balloon payment is a one-time, bigger-than-normal payment you make at the end of the payoff period for a loan like a mortgage, auto loan or business loan.

Read on to learn more about balloon payments.

Key takeaways

• A balloon payment is a one-time, larger-than-usual payment made at the end of a loan term.
• 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.
• If a borrower can’t make a balloon payment, they may need to refinance their loan or sell the asset purchased with the loan money.

A balloon loan offers relatively low payments throughout the life of the loan—until the final payment comes due. At that time, a lender requires a borrower to make a heftier payment to pay off the remaining loan balance.

Aside from lower monthly payments, potential benefits of a balloon loan include:

• The ability to borrow more than you would with a traditional loan
• The availability of a loan with a short payoff period—often three to seven years

A balloon loan comes with equal monthly payments leading up to the final payment. The final payment—known as a balloon payment—typically far exceeds the borrower’s previous monthly payments.

A balloon payment is due at the end of a balloon loan’s term. So, if someone takes out a three-year balloon loan, they would make the balloon payment at the end of the three-year period. Once the borrower makes the balloon payment, the loan should be paid off in full.

Various types of installment loans—or those you pay back over a specific period of time—may feature balloon payments.

A mortgage with a balloon payment may be the most familiar type of balloon loan.

When a borrower takes out a balloon mortgage, they agree to make low or even no monthly payments for, say, five to seven years. Based on how the mortgage is set up, the monthly payments may be earmarked just for the interest or for both the interest and principal.

Once the borrower makes all the monthly payments, they are supposed to come up with a large balloon payment to pay off the remainder of the mortgage. The Consumer Financial Protection Bureau cautions that a balloon payment generally is more than two times the loan’s average monthly payment and might total tens of thousands of dollars.

Like a balloon mortgage, an auto loan with a balloon payment enables a borrower to make smaller monthly payments throughout the life of the loan until the final balloon payment comes due.

The balloon payment for an auto loan might be up to half the entire loan amount. Furthermore, the auto lender might charge a higher annual percentage rate (APR) for a balloon loan than it does for a traditional loan. 

A business loan might also include a balloon payment. The borrower makes initial monthly payments that are lower than the final balloon payment—a payment that could be hundreds of times bigger than each monthly payment was.

Before taking out a balloon loan, consider asking these questions:

• Would the APR for the balloon loan be higher than the APR for a traditional loan?
• How much would the monthly payments be?
• Would the lower monthly payments be worth it if I need to make a large lump-sum balloon payment at the end of the loan?
• Would the monthly payments go toward only the interest or would they cover the interest and principal?
• How much would the balloon payment be?
• When would the balloon payment be due?
• Would 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?

If a borrower wants to eliminate a balloon payment, several options are available:

• Refinancing the loan. But keep in mind that refinancing is not a guaranteed alternative. In the case of a mortgage, for instance, a borrower might not have built up enough equity yet to qualify for refinancing. Or the borrower’s credit might not be healthy enough to be approved for a refinancing loan. And it’s worth considering that a refinanced loan may hit a mortgage borrower with thousands of dollars in closing costs.
• Selling the asset. Although it’s not an ideal option, a borrower might sell their home or car, for example, if they’re unable to come up with the balloon payment.
• Negotiating a loan extension. If the balloon payment puts a borrower in a financial bind, they might approach their lender about an extension of the loan’s payoff period.

A balloon payment is made at the end of a balloon loan’s term and is a one-time, larger-than-usual payment that pays off the remainder of the loan balance.

Balloon loans can be an alternative to traditional loans for things like homes, cars and businesses. And while they usually come with lower monthly payments than traditional loans, they may have higher interest rates. The balloon payment can also be significantly larger than the loan’s monthly payments, which can make it difficult for borrowers to pay them off.