Loans can be repaid in a number of different ways. The creditor might be expected to pay back the money in regular equal amounts over a certain amount of time until the debt is repaid. This is not the only way of doing things though. A balloon payment refers to a large lump sum that will be due at certain times during the repayment period. In a lot of instances this large payment will be made at the end of the loan.
How a Balloon Payment Works
This type of payment gets its name because of the way it works. This is because the last payment or payments of the loan will tend to be quite large due to compound interest over the course of the loan. The lender may have only had to pay a modest amount in the past but now they have a large amount to pay at the end. There are many advantages to this type of arrangement and this is why a lot of people will chose this option.
The Benefits of a Balloon Payment
This type of payment agreement is perfect for those people who are expecting to have a lot of money in the future. Even though they might struggle to repay the loan if it was spread out equally over the term of it they can postpone paying a lot of money until further down the road. In the meantime they can make use of freed up capital to help their business grow and expend so that it will be in a better position to make the large payments required later. This money can also be used to invest with in the hope that it will provide a large sum that can be used to make the balloon repayment.
Banks will not give this type of balloon loan unless they are sure that the borrower will be later able to make the large repayments requirements. If the creditor has no evidence of a future windfall they will be expected to set aside money each month which will later be used to make the payments. A vague hope that finances are going to improve in the future will not be enough to satisfy lenders. They will want more reassurance then this or else it would be too much of a risk.
The fact that the repayment isn’t required until a later date means that the borrower is free to invest this money in the meantime. It would not be advisable to invest this money in high risk ventures though because it could mean that they have nothing when the time comes for payment of the loan. It is also recommended that those who do want to invest the money only choose low risk options.
Some Final Thoughts on Balloon Payments
This method for paying back a loan can be a good choice for those people who are confident of having a lot of money in the future. It is not a good choice for those who are uncertain about the future.