When securing financing for any purpose - comparing the market and self-educating is vital. Which is probably why you’ve made your way here… asking yourself what is a balloon payment?
In this guide, we will discuss what a balloon payment is, examples of a balloon payment, how you can avoid this payment, and the advantages and disadvantages that exist when incorporating a balloon at the end of a loan term.
What is a balloon payment
A balloon payment is the final amount due on a loan that is structured as a series of small monthly payments. The ‘balloon’ is a single much larger sum due at the end of the loan period.
Finance with a balloon is a loan product that offers lower repayments throughout the loan term and is popular among those seeking lower weekly, fortnightly, or monthly repayment structures. A balloon can often help individuals maintain a reasonable cash-flow or savings and are offered as an option for home mortgages, Vehicle loans, and business loans. Generally only borrowers with high creditworthiness will be considered to take out this form of loan.
As the term ‘balloon’ hints - the final payment on this type of loan can be quite large. However, this sum is dependent on the length of the loan term, asset type, and the value of the asset. At the end of the loan term, there are a few options an individual can choose to take:
- Payout the balloon in full and keep the asset
- Sell the asset and payout the balloon with proceeds from the sale
- Keep the asset and refinance the balloon for a further term
It is important to note that balloon loans usually require collateral. For home or car loans, you may have to secure the loan with the asset which means if you default on your loan and can’t satisfy the balloon payment, the lender has a legal claim on your vehicle or property.
There are many advantages and disadvantages to opting for a loan with a balloon payment. To understand these in more detail, keep reading.
Examples of Balloon Payments
As briefly mentioned above, balloon payments are most commonly used in mortgages, Vehicle loans, and business loans.
Vehicle Loan
If an individual has an urgent need for a vehicle but can’t immediately afford high monthly payments, a balloon loan can be used. Although not as common as business loans and mortgage loans, it is often relatively easy for a borrower to secure this type of loan in the Vehicle lending industry.
Business Loan
If a business has a proven financial history or favourable credit record, they can usually secure a balloon loan relatively easily. Businesses are typically in a better position to pay off a lump sum than individuals and for this reason, lenders will often consider businesses less risky for this type of loan.
Mortgage
At Jade Finance we don’t offer property loans, however it's still important to discuss balloon payments at the end of a mortgage. Balloon mortgages are rarely used for traditional 15-30 year mortgages because lenders don’t want to wait that long to recover their money. So, generally for balloon mortgages, lenders prefer a five-year to 10-year loan term.
How to Avoid a Balloon Payment
If you have a looming balloon payment at the end of your loan term, you might be starting to feel the pinch. If you are in need of eradicating this payment, there are a few options you can take.
- Refinance the loan
Some lenders may be willing to repurpose a borrower's debt into a different loan, or modify the terms of the agreement. - Sell the underlying asset
To avoid defaulting on the loan, a borrower may choose to liquidate the asset to avoid paying the balloon. - Pay the principal amount upfront
A borrower may have the option to pay a portion of the debt early. However, it’s important to check that your lender doesn’t have any prepayment penalties or fees prior to doing this. - Negotiate an extension
Similar to refinancing, the terms of the loan can potentially be adjusted. Instead of receiving a new loan, a borrower will just have the timing of the balloon payment moved to a later date.
What are the Advantages and Disadvantages of Balloon Payments?
Financing a lump sum balloon payment at the end of a loan requires careful consideration. While balloons offer some good benefits, there are also just as many disadvantages to consider before making such a big financial commitment.
Advantages
- Lower repayments
Balloon payments are popular because they allow you to repay your loan with lower weekly, fortnightly, or monthly repayments.
- Shorter loan commitment
Instead of payments stretching over 5-6 years, balloon loans generally only commit you to 2-3 years of payments. This may appeal to a borrower who only wants to drive a certain car for a few years.
- More control over cash flow
The lower monthly, fortnightly, or monthly repayments make it easier to budget and manage your expenses. It also frees up extra money.
Disadvantages
- Harder to qualify for
Qualifying for a balloon loan is generally harder due to the higher credit preferences by lenders.
- Higher overall cost
Due to the riskier nature of the loan from the lender’s perspective, balloon loans will often have high interest rates. This can lead to a higher total loan cost.
- Payment might come as a shock
Although you have signed up for this loan type, your circumstances may have changed significantly since then. If this is the case, you might not be prepared for a big payment to cover the balloon. If you have not planned or budgeted for this big expense, you could be left in a tricky situation.
Closing Thoughts
Balloon loans are relatively popular in the financial market, but are generally only available to those able to make a large down payment, and with a very good credit rating. Prior to considering a balloon payment, it is important to speak with an experienced broker and conduct thorough research to ensure you are getting the best finance product for you.
If you’re not sure that a balloon payment is the best finance solution for you, there are a wide variety of other loan options available that you can access by speaking to one of our expert brokers at Jade Finance.
Want to finance your next business loan with a balloon payment?
JADE Finance Australia is the only place you need to look. As balloon payments are a popular financing product, most banks and finance companies offer it. However, at JADE, our experienced brokers are not limited to one offer by one source. We have a large portfolio of lenders who we will compare and assess to find the best deal for you and your business. Save yourself time and paperwork by calling JADE Finance.
For further financing information or to request a quote, contact us today.
Please note the information provided in this guide is for general educational purposes. Speak with a broker at JADE Finance to see if a balloon loan is right for you.
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