A balloon payment is a lump sum due at the end of a balloon loan term.
In a balloon loan arrangement, the payment schedule does not amortize the entire amount of the loan, but instead allows for lower installment payments by holding a lump-sum payment until the end of the term.
These terms are usually relatively short, such as 5 years, and often these arrangements are taken by individuals or consumers who plan on refinancing before the balloon payment comes due.
Some balloon loans contain a reset provision that allows the borrower to automatically be approved for a new financing arrangement instead of paying the balloon payment when the initial term in over.
The interest rate on the new financing arrangement is determined at the time of the reset. Some balloon loans do not have a reset provision. These tend to look like a coupon bond where the borrower is a bond issuer and the principal is repaid at the end of the term.
Some businesses or individuals might find this agreeable, such as contractors or commercial real estate developers who are paid lump sums as much as a few years after a project begins. For others, this can be a precarious situation — balloon payments can be significant sums of money, and some borrowers could find it impossible to pay such an amount when it’s due, despite their best intentions.
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