Whether you’re setting up a new business or are looking to put some money into an existing venture to really help get a project off the ground, you’ve probably considered taking out a loan. There are many different types of loans, which are underpinned by specific repayment schedules. The balloon payment is a term that you will often come across, but what exactly does it mean? Let’s find out.
What is a balloon payment?
A balloon payment is a large, one-off payment that is due at the end of the loan term. This lump sum amount is preceded by a stream of constant payments. If a balloon payment isn’t required to pay the remaining balance of a loan, it’s fully amortized, and solely consists of a series of fixed, equal payments that are met through the life of the loan.
If your loan has a balloon payment option, it will typically result in lower monthly repayments, because you are deferring part of the cost to the end of the contract. These loans are ideal for commercial borrowers who have excellent credit and ample income, as well as companies that are lacking in cash but expect liquidity to greatly improve in the future.
It’s important to realize that there are risks involved in taking out balloon payment loans. As a borrower, your financial circumstances can change suddenly, so there is a danger that you may not be able to afford the lump sum payment, which will leave you with a large outstanding debt. For this reason, there are strict lending criteria for balloon loans.
Examples of balloon payment loans
Within business, balloon loans are often used for short-term financing needs and commercial real estate purchases. If your organization needs working capital and is waiting for a large payment from a customer to come through, a balloon loan can be an affordable way to provide gap financing. Another benefit of a balloon loan is if you are looking to move into a new office before selling your old one. The deferred payment schedule of a balloon loan allows time to make a sale on the old property.
If you’re taking out a mortgage on a house, there may be a balloon payment opportunity available. Balloon mortgages allow buyers to finance properties with low monthly mortgage payments. For example, with an interest-only mortgage, your monthly payment consists solely of the interest charges on your loan, not any of the original capital borrowed. This means your payments will be less, but at the end of the term, you will still owe the original amount you acquired from the lender. These kinds of loans are typically used by homebuyers with high net worth.
Balloon payments aren’t as common for car loans as they are for business loans or mortgages. Nonetheless, because lending restrictions are less stringent in this particular industry, it’s somewhat easier for consumers to take out this kind of loan. The total cost is spread out in a different way, however, that doesn’t mean it’s more affordable.
How to calculate a balloon payment?
If you need a simple balloon payment calculator, look no further than Microsoft Excel. You will need to know your annual interest rate, loan amount, the duration of your loan (in years) and your monthly payment. All of this information can be found on your loan agreement.
Open a new worksheet, create labels for your variables and then input the information into the adjacent cells.
Next, set up the equation using the future value function (FV). The function will prompt you for variables as follows: =FV(rate, nper, pmt, [pv], [type]).
Once you’ve done this, some changes must be made to some of the variables when they are entered and they must be entered in the right order. You will need to input your periodic interest rate, total number of payments, monthly payments and loan amount, as prompted.
Press enter to solve your equation. If you’ve entered everything correctly, the answer will be a negative number. This number will be the balloon payment due at the end of your loan.
Using an online balloon payment calculator is also recommended, as mistakes can be made using the above method. As always, double check your source is reliable and ensure you have all the information you need to hand.
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