Balloon Payment Explained

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A Balloon Payment occurs when the payments on a loan are amortized over a longer period than the term of the loan. A loan may have a term of 3, 5, 7, or 10 years, while payments are amortized over 20 to 30 years. In this case, the final payment required to pay the loan off is called a "balloon payment" because it is higher than the previous payments.
Amortization is the rate at which principal is paid down on a loan. A fully amortizing loan would have all of the principal paid down to the end at the last payment. But in the commercial world, lenders typically don't want to make 25 or 30 year loans. So quite often in commercial lending, we see loans that have partial amortization.
Commercial lenders typically prefer to make 3, 5, 7, or 10 year loans. Not always, but often. However, if payments were amortized over, just say 10 years, then they would be astronomically high, and borrowers wouldn't be able to afford the payments and still have positive cashflow. So what's a very common is lenders will make a shorter term loan, but amortize the payments over say 25 or 30 years.
The advantage of this is that it reduces the monthly burden and increases the cashflow for the borrower. So at the end of the loan term, the borrower ends up with what's called a balloon payment, and that balloon payment is just simply paying one last final payment that pays down the rest of the entire loan balance on the final payment.
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[@RealEstateFinanceAcademy]

QOTD: What lessons or concepts would you like me to teach? Tell me below! - Trevor

[@armandosantana938]

let's say I have a 30-year amortization with a balloon payment in the 20-year mark. flash forward, balloon payment comes and I can't pay the full amount. will the debt just continue for the remaining 10 years?

[@RealEstateFinanceAcademy]

No! The full amount is due at the maturity date. At that point you have three choices: Refinance, sell and pay off the debt, or go into default -> Default interest rate, foreclosure, legal costs, etc. What you want to do with the property going forward will help define your best financing strategy. Contact me if you want to talk about it. Happy to help. - Trevor

[@socketyellow3]

If you can’t afford the normal payments your are essentially gonna be hopeful that you win the lottery or something. This sounds like a terrible loan for normal people

[@RealEstateFinanceAcademy]

Yes, if by “normal people” you mean your average home loan borrower, then you are correct. Balloon payments are primarily used in shorter-term commercial loans (office, retail, multifamily, etc.) It’s much less common to see balloon payments in residential mortgages (home loans.)

[@GR.33.]

After the balloon payment, the next 10 is paying of interest correct?

[@RealEstateFinanceAcademy]

No, the Balloon Payment is the final payment on the loan. At that point, typically one is either going to refinance or sell the property. - Trevor

[@jacksonwhitaker8201]

a balloon payment is also called a lump sum right?

[@RealEstateFinanceAcademy]

Essentially, yes. 👍🏻