Balloon Loan: What They Are, Are They Worth It, Pros & Cons

If you’ve been in the process of applying for a loan, lenders might have offered you balloon loans at some point. You must research well before choosing the right loan, but there are so many. What is a balloon loan? How does it work, and what are its pros and cons? By the end of this article, you will be more informed about balloon loans and how they might be the right choice for you!

What Is a Balloon Loan?

Balloon loans are different from most lending systems taught to the public. They involve lower monthly payments with a large payment at the end of the term. These loan terms are shorter than traditional loans and are usually offered for auto loans, mortgages, and business loans. They can help lower interest rates and allow you to make lower monthly payments so the loan doesn’t affect your monthly cash flow.

While it may be tempting to automatically opt for balloon loans, pay attention to the lump-sum payment you have to pay once your loan’s term is over.

How Does a Balloon Loan Work?

Balloon loans work by letting people pay the majority of their loans, along with interest, at the end of the period. Monthly payments can be divided into two types: interest-only and interest with a bit of principal amount.

With interest-only options, you pay the loan’s interest as your monthly payments and make a lump sum payment of the principal balance. For example, if you take a $100,000 loan over 7 years, and the monthly interest comes to around $3,500. In an interest-only payment plan, you pay $2,000 a month for 6 years and make a huge payment of $79,000 at the end of the loan’s term.

Many balloon loans also offer a partially amortizing loan payment: along with interest, you pay a part of the principal amount. Using the previous example, instead of $3500, you can pay $7000 a month. $500 will be subtracted from the principal amount. At the end of the loan term, you have to pay $30,000.

Like previously mentioned, balloon loans are usually chosen by people with a bad credit score who want a mortgage to buy a home. It helps lower their monthly payments, and many others choose to amortize the loan; those who are buying a car or have business needs without significant cash flow also look towards balloon loans.

Key Takeaways

Balloon Loans: Pros and Cons

Balloon loans may seem like an affordable option, especially if you’re buying a house or looking for a balloon auto loan. However, these offers should only be your option if you have stable income streams and can repay the massive backend payment when it’s due.

Before you make your decision, consider the pros and cons of balloon loans.

Pros

• Low initial payments.

As we mentioned, balloon loans have low starting payments. They’re suitable for people who don’t want to affect their cash flow or make a large down payment when accepting the loan.

• Affordable short-term capital.

These loans are also suitable for short-term borrowers. Usually, short-term loans have high interest rates, but balloon loans work differently. They provide an affordable option as low initial payments to borrowers.

• Low balloon mortgage rates.

Balloon loans usually have low-interest rates and offer affordability to people. However, this is only because of the large amount owed once the loan term expires.

• Easy to qualify.

Balloon loans do not require an excellent credit score. An average credit score can qualify you for this type of loan since most of these loans are short-term and used by those who lack consistent income.

Cons

• High closing costs.

Now that we’ve covered the balloon loan definition and the way it works, a major con is a large amount you have to pay at the end of your term. It’s not easy for everyone to get a large amount of cash at one time, even after a few years.

• Risk of foreclosure.

Mortgage foreclosures are a big problem in the US and happen when homeowners fail to make payments on their homes. There are many things you should know before buying a house, and paying is the most important one. Consider your savings, balloon mortgage pros and cons, and your income; do not fall buy a house outside of your budget! There are several ways you can buy a house, even with a lower income.

• No guarantee you’ll be able to refinance.

Most traditional loans provide a reset option if you’re not able to keep up with payments, which helps the lender and borrower reconsider loan terms and work out an agreement. This can include a reduction, a higher interest rate, or increasing the loan term. Refinance also refers to taking on another loan to pay off the current one. This option of refinancing is not available with balloon loans and can severely impact your income and credit score if you fail to pay on time.

How to Pay off Balloon Loans

You must know how to calculate a balloon payment if you’re planning to take out a loan. Take a look at your finances and determine your maximum monthly payments, as well as the final bill. Having enough savings, especially if you’re saving for a house, can help you make payments without making a financial debt. Start planning before you take out a loan to ensure you can make payments to reduce the risk of skipping.

If you have limited pay-down funds, you can also try refinancing. Some lenders might deny this, but it doesn’t hurt to try. If they approve, you can discuss lowering your lump-sum payment or increasing the time. Lastly, you can use refinancing to take a new loan to pay off the previous one if you don’t have substantial income, which can work well for balloon mortgage payments.

Conclusion

Balloon loans allow a borrower to make minimum monthly payments with a large lump-sum payment when the loan term is up. It has a few advantages like low monthly payments, low-interest rates, and ease of qualification. A major disadvantage, however, is the amount of cash you need to come up with at one time. You must plan your finances correctly if you’re planning to take out this type of loan. Good luck!