What Is a Balloon Note Payment: Everything You Need To Know
What is a balloon note payment? This is a large payment due at the end of a loan that will pay off the balance.3 min read
What is a balloon note payment? This is a large payment due at the end of a loan that will pay off the balance. It is often equal to around two times the average monthly payment of the loan. It doesn't matter the amount that is due; you are required to pay the entire balloon payment when it's due.
What Are Balloon Loans?
Recently, balloon loans have earned a bit of a bad rap. Many financial experts feel balloon mortgages are the cause of the Great Recession that started in 2008. That makes a lot of people curious what a balloon loan is and how it could be responsible for causing a recession.
Essentially, a balloon loan only requires the borrower to pay the interest payments the first few years of the loan. A traditional loan is where you pay a portion of interest and the principal, which is the amount you borrowed. With a balloon loan, you would only pay accrued interest on the loan, which is a much smaller payment than a traditional loan.
Balloon Loan Disadvantages
This creates a problem because the lender will obviously want the principal paid off at some point, usually between three and seven years. When the deadline arrives, you are expected to pay off the entire loan in one large payment, known as the balloon payment. It's not uncommon for the balloon payment to be tens of thousands of dollars.
Another drawback with balloon mortgages is the lack of equity you build up in your house. Equity is an important resource for homeowners as it can provide you with an emergency source of funds, which is often acquired through a home equity line of credit or loan. It also helps ensure you get a decent chunk of money when the house is sold since a traditional mortgage will shrink over time as more payments are made. Borrowers with a balloon mortgage don't have those resources.
You may notice lenders promoting balloon loans by stating that you have the ability to refinance the loan or sell the home prior to the balloon payment coming due. While it's a possibility, what happens if you cannot get either one of these options to work for you? If the housing market dries up and no one is buying new homes, or your home value drops so you can't get enough to cover the balloon payment, you are in financial trouble. There are other factors to consider, like your credit score or your job security.
These issues are what home buyers were facing in 2008. Massive widespread layoffs mixed with decreasing home values left a large number of buyers trapped with balloon loans they couldn't pay. Many homeowners couldn't sell or refinance, forcing them into foreclosure. With home values low, the banks couldn't sell the homes either, which further hurt the economy in the United States.
What Is the Procedure When a Balloon Payment is Due?
If a balloon loan is an option for you, it's important to plan for the balloon payment note due date. You should start planning before you even apply for a loan. In most situations, the applicant handles the balloon payment using one of these methods:
- Refinance — Pay off the balloon payment by getting a new loan, which is known as refinancing. You will have a brand-new loan that has a longer repayment period. In order to qualify, you must have really good credit and enough income. Borrowers who refinance will stretch out the loan, and you pay more in interest because the repayment period is longer. If interest rates are the same or have dropped, it's a positive for you. If they have gone up, it would've been better to use an amortization loan.
- Sell the Home — The other most common option when dealing with balloon payments is to sell the home. You can sell it and use the proceeds to satisfy the remainder of the outstanding loan. The problem here is if the home is not worth enough to cover the loan balance. During the mortgage and housing crisis, many borrowers found their homes were worth significantly less than what was owed.
- Pay Off the Home — If you have plenty of cash, just pay off the loan when the balloon payment is due. This is the least common option. If most people had this amount of money at their disposal, they would not be borrowing in the first place.
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