What Are Balloon Loans and Balloon Payments?

Many amortized loans — including some used to acquire apartment properties — are structured with relatively short terms in which only a portion of the principal amount is amortized over that period. When a loan like this arrives at its maturity date, there is typically a large sum still due to be paid by the borrower that accounts for the portion of principal that wasn’t amortized over the loan term. Because of the large size of the payment due at the end of the loan term, the sum is often referred to as a balloon payment, and the financial instrument it is attached to is often called a balloon loan.

With many balloon loans, the borrower initially makes monthly installments at a set interest rate for a set number of years. When this initial period comes to an end, one of two things can happen. In some cases, the loan resets, causing the balloon payment to be rolled into a new (or continuing) amortized mortgage. The new, reset mortgage adopts the prevailing interest rate of the market at the time the initial period ended. Balloon mortgages do not reset automatically, however, instead depending on several factors like whether or not the borrower’s income remains consistent and whether payments on the note were made on time each month. Should any factor prevent a balloon loan from resetting, the borrower is then responsible for making the balloon payment.

For an investor, planning for a balloon payment is critical. After all, in most cases, a balloon payment is at least double the value of the monthly installment amount — and can stretch in value to tens or even hundreds of thousands of dollars. In order to avoid having to pay such a hefty amount in one installment, many investors choose instead to either sell the asset or refinance the loan before the balloon payment becomes due.