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A balloon payment is a large, lump sum payment made either at specific intervals, or more commonly, at the end of a long-term balloon loan. Balloon payments are most commonly found in mortgages, but may be attached to auto and personal loans as well. In exchange for this large final payment, the person taking out the loan reaps of a number of benefits. Usually, the initial amount of cash which must be put down is less than it would be under a standard loan agreement. More importantly, however, is the lower interest rate throughout the life of the loan, and smaller monthly payments. Balloon loans are ideal for people with good investment sense, and the ability to wisely manage and ration their spending. By freeing up capital that can be dedicated to paying down higher interest rates and making larger payments, balloon loans give a savvy investor the opportunity to use that capital to save money. These loans make a lot of sense for individuals expecting a financial windfall at some point in the future. This might be due to a large tax refund, an inheritance, or an expected dividend. Whatever the source, if current cash-flow is not indicative of future capital holdings, a balloon payment may be an intelligent choice. Most lenders will want some sort of assurance that the final capital for the balloon payment will appear, though it is becoming more common for lenders to be freer with the granting of balloon loans. It is imperative, if a large sum of money is not expected to appear, that the borrower pay careful attention to setting aside a minimum amount each month to guarantee they will have the money when the balloon payment rolls around. For this reason, investing saved capital in high-risk markets is not recommended to those on a balloon payment schedule. Rather, it is suggested to place the extra money in safe growth arenas. Given the long-term nature of most loans balloon payments are scheduled on, this is rarely a problem. Many lenders will allow you to convert your initial balloon loan into a more traditional loan structure, on or near the date the balloon payment becomes due. Make sure this is an option beforehand, however, and be certain you are willing to risk refinancing at much higher interest rates when the time comes, before you make the leap. Balloon loans and the associated balloon payments are very attractive due to their extremely low interest rates, but they are often viewed as being too risky for most first-time borrowers. If you are not absolutely certain you can handle the dangers of an impending balloon payment, you may want to look into a similar, but somewhat safer, option, such as adjustable-rate mortgages (ARMs). ARMs carry similarly low interest rates, with the danger being that they are not fixed, and so may fluctuate to be higher than current market interest rates.
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