Balloon Payment - Meaning, Benefits & Requirements of Balloon Loans and Mortgages

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Balloon Payment - Meaning & Definition

By applying for a home loan, borrowers agree to pay monthly EMIs comprising a part of the principal amount and interest thereof for the entire tenure of the home loan. Paying off the home loan with monthly fixed payments reduces the outstanding balance of the home loan.

However, when you opt for a balloon payment loan, you pay a lump-sum amount only at the end of the loan's tenure to close the loan. The monthly payment on such a loan is small. Borrowers with substantial credit ratings and earnings can benefit from balloon loans.

What is a Balloon Mortgage?

Borrowers agree to pay fixed sums for a specified period when they apply for home loan. However, when the home loan tenure ends, they will have to pay a lump-sum amount and close the loan. The balloon loan payment the borrower makes is the final lump sum payment.

For instance, Suppose Amar applies for a 5-year home balloon loan for ₹4,00,000 at the rate of 4.5% interest on a home loan (balloon loans have lower interest rates than traditional home loans). He will have to pay a monthly mortgage payment of approximately ₹2000. When the home loan tenure ends, Amar must make a balloon payment of ₹3,66,000.

What is a 5-year Balloon Payment Loan?

Amortisation is typical for home loans. It refers to the decrease in outstanding loan amount via EMI payments, including the interest on the due loan amount and part payment of principal. When the home loan tenure, which is 20 to 30 years, comes to an end, there will be an instalment of the loan amount to pay off and close the loan.

But with a balloon loan, the borrowers will still have a substantial amount outstanding in their home loan account that they must pay. These are non-amortised home loans, and some end in 5 years; such loans are 5-year balloon payment loans. In the fifth year, the borrower repays the outstanding mortgage amount, which is substantial.

How Can I Benefit from a Balloon Payment Loan?

Balloon payment loan, although it has its risk, as stated in the section above, can also be beneficial to the borrower in the followings ways:

Balloon home loans are affordable because banks and NFBCs offer them at lower interest rates.

The monthly mortgage payments or balloon EMIs are generally smaller than regular home loan EMIs.

If a borrower opts for a balloon loan, the lender may sanction a higher amount of loan than if they were to apply for fixed interest rate or variable rate home loans.

Why do Borrowers Hesitate to Apply for a Balloon Home Loan?

The general understanding from the above example is that the borrower will only be able to make such a substantial payment if he has some rolling cash or some huge return coming through that he can use to pay off the mortgage. Here are some more reasons why borrowers hesitate to apply for a balloon home loan:

A balloon mortgage was the ideal home loan for borrowers looking for a cheaper funding home to buy real estate. The general idea is to start with smaller payments, at the end of the tenure, opt for the refinancing option and pay the entire outstanding amount.

However, around the mid-2000s, the balloon loan payment began to lose popularity. The reason- was the great recession, which resulted in the fall of real estate market rates. Thus the borrowers could not use the refinance as planned and ended up as defaulters as they could not pay the final amount.

Thus many borrowers had to sell their housing properties at lower rates and lose heavily. However, some lenders in India still offer their customers balloon home loans. Such loans are helpful as home loans as they generally have a tenure varying between 20 to 30 years per borrowers' desire.

The home loan EMIs are part of the payment of the home loan principal and interest on the outstanding amount. The balloon home loan can be more expensive if it is an interest-only home loan. That's because the outstanding amount doesn't reduce during the balloon home loan's tenure. And the calculated interest is on the whole home loan amount.

Balloon Payment Requirements

The borrower must pay a balloon payment at the end of the home loan tenure. As the balloon payment amount is generally substantial, it can be risky. The borrower must opt for such a loan only if they satisfy the following requirements:

The balloon home loan is advisable for those who expect investment to yield a substantial return at the end of the balloon loan tenure, by which they afford to repay the balloon mortgage.

Those earning significant salaries or profits from the business will have no issues paying the amount at the end of the loan tenure.

How to Make Balloon Loan Payments?

A home loan is borrowing, and repayment is inevitable. Thus borrowers need to have a balloon repayment plan in place even before planning a balloon loan. Here are two ways of handling balloon payments:

Borrowers must maintain their creditworthiness and assets before the balloon payment due date. The reason is the maximum eligibility to opt for a new loan or use the refinance option. If they can secure a new loan, they will receive an extension period to repay the balloon mortgage.

Borrowers can sell the house purchased with the balloon home loan. But they can only clear the loan amount if they can sell the property for the required amount. It is thus essential to buy a home where the real estate rates are sure to rise to help them comfortably pay off the balloon mortgage.

Conclusion

Balloon home loans are risky because you must pay a substantial amount to pay off the balloon mortgage. However, it is beneficial because the interest rates and balloon EMIs are low, and careful balloon repayment planning can make it easy to repay on time and save much money.

Balloon Payment Loans: Definition, Benefits, and Requirements Unveiled

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