A balloon payment is an unusually large payment due at the end of a mortgage or loan. Since the payments are not spread out, this large sum is the final repayment to the lender. Holding back most of a debt and paying it only towards the end of the agreement makes both those last payments and the total amount repaid much larger. The name comes from the fact that the debt becomes inflated like a balloon as a result of the compound interest accumulating on the large sum. Another, more technical term is partial amortization.
A related piece of jargon is the bullet payment. When a large debt has to be repaid entirely in one big payment it can be financially crippling, making it a metaphorical bullet to the head of a company which does not have the cash on hand.
With a bullet loan, a bullet payment is paid back when the loan comes to its contractual maturity—e.g., reaches the deadline set to repayment at the time the loan was granted—representing the full loan amount (also called principal). Periodic interest payments are generally made throughout the life of the loan.
The more usual arrangement for repaying a loan is called amortizing payment or amortization.
With amortization, portions of the principal are periodically being repaid (along with the loan's interest payments) until the loan matures. With full amortization, the amortization schedule has been set so that the last periodical payment comprises the final portion of principal still due.
With partial amortization, a balloon payment will still be required at maturity, covering the part of the loan amount still outstanding. This approach is very common in automotive financing where the balloon payment is often calculated with respect to the value of the vehicle at the end of the financing term—so the borrower can return the vehicle in lieu of making the balloon payment.
Balloon payments or bullet payments are common for certain types of debt. Most bonds, for example, are non-amortizing instruments where the coupon payments cover interest only, and the full amount of the bond's face value is paid at final maturity.
Balloon payments introduce a certain amount of risk for the borrower and the lender. In many cases, the intention of the borrower is to refinance the amount of the balloon payment at the final maturity date. Refinancing risk exists at this point, since it is possible that at the time of payment, the borrower will not be able to refinance the loan; the borrower faces the risk of having insufficient liquid funds, and the lender faces the risk that the payment may be delayed.
Famous quotes containing the words balloon and/or payment:
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