A final loan
payment that is considerably higher than prior regular payments, in
order to pay off the loan. You may have a balloon payment for a
short-term loan that you anticipate refinancing.
On
a traditional mortgage loan, borrowers pay only interest for several
years. Then, as they still pay off interest, more of their monthly
payment goes toward chipping away at the principal. At the end of
the term, they owe nothing.
But loans that
are not fully amortized -- where the principal is NOT paid off over
the life of the loan -- are set up for a "balloon" payment. This is
when the borrower has been paying only the interest, or some
combination of interest and principal, and when the loan term
expires the balance is due in full.
The balloon
payment is more common to second mortgages. If you borrow $20,000,
for example, and your monthly payments for 10 years have included
only interest, you must fork over the $20,000 in principal at the
end of the term.
Borrowers
sometimes do this to make their monthly payments more manageable.
But after coasting along with easy payments, a balloon payment can
be an ugly ending. You don't know how interest rate cycles are going
to change several years down the road, and you can't look into the
future and know the exact worth of your home. And if you can't pay
your balloon off at once, you could lose your home.
Some borrowers
refinance the loan, obtain another loan or sell their house to pay
the balloon.
The bottom
line: Steer clear of balloon payments. If you can't, make sure, make
very sure, you can sell your house or come up with the money some
other way.
