What is it? A Balloon loan payment is a fraction of the entire loan payment where you pay a lump sum at the end of the loan term.

This involves reduced payments during the loan tenure that last for about 5 to 7 years after which the debt balance can be settled.

The pros and cons of Balloon loans?

As with every other form of a financial loan, even the balloon loan comes with its own set of advantages and disadvantages.

Advantages
• The low-interest rates offered by a balloon loan can be quite advantageous initially for the right customers.
• In the case of homeowners who plan on staying in a house for a short period and selling it afterwards, a balloon loan makes sense since the lump sum from the sale of the property can be used to pay off the loan.
• For employees who earn bonuses at the end of financial years, the accumulation of this amount can be used to pay off balloon loans.

Disadvantages
• The time frame for the repayment of the balloon loan is quite small and results in a difficulty when it comes to paying up the amount.
• Balloon loans can result in higher costs in the long term if the loan repayments are not made on time. This makes the balloon loan quite risky.
• If the loan amount is large, defaulting it could result in bankruptcy.
• The lump sum payment that is to be made at the end of the reduced loan payment term can cause quite a financial strain if the funds are not available at the time as the total principal amount is relatively high.
• The problem with taking a balloon loan on the house for a short period is that the house might depreciate thus declining the value if will fetch during a sale. This amount might not be enough to cover the lump sum required to clear the balloon loan due to the negative equity.

Does it work for small businesses?

A Balloon loan works best for businessmen who face a cash crunch at the inception of the business but expect faster liquidity in the near future. This is also referred to as borrowing money on a promissory note. For a small business that has immense potential, this sort of loan could prove beneficial. With the reduced principal payments of a balloon loan, the venture can grow, and payments can be made at ease. The process of amortisation can be of assistance for small businesses that are struggling to find their feet. However, if the small business does not thrive, they can find themselves in quite a predicament by not paying the loans back.

If the balloon loans cannot be paid up at the end of the loan tenure, it is best to refinance your loan to avoid financial burdens. The Balloon loan acts as a bit of a double-edged sword. It is important to assess the plus points as well as the drawbacks before jumping headfirst into a financial situation such as this.