Fictionary : Balloon Financing

The term “balloon” essentially means a financial contract in which a large, one-time payment at

the close of the term is made. It refers to monthly payments usually lower than traditional

financing mechanisms resulting in the final, larger, balloon payment payable at the end of the

finance contract. Due to this, the consumers spend less on a monthly basis, however they are

responsible for the balance left on the finance contract based on a predetermined time.

BY SIRJAN KAUR KOHLI | 3 mins read

Consider how a balloon mortgage works. Essentially, these home loans have terms of 5-7 years,

however the payment is calculated on the basis of a 30-year amortization. Lower payments over

the term of the loan can be enjoyed, but once the term is up, the possibility of selling or paying

the outstanding amount owed through refinancing the loan or paying with own funds. The same

principle also holds true with balloon auto financing; where there is a predetermined term and

payments at fixed installments until the final lump sum is due. As with the mortgage, the

payment of the balloon amount will have to be made, and that might also eventually lead to

refinancing.

In balloon financing, the monthly payments are actually lower than payments in a regular

financial contract, but the APR rate is generally higher. This provides flexibility for better

management of cash flows through the term of the financing. Financially savvy consumers have

the option to use the extra cash for themselves each month however they choose, anything from

investments to other expenses.

Having one large lump sum of money due at the end of the finance contract can be problematic

for the investors at times. A balloon financing contract could be of help and beneficial only if

there is preparation to have the necessary amount ready to make the balloon payment as it is

due. The balloon amount can be paid off through the vehicle. However, because resale values of

vehicles and their credit conditions may and do change, they cannot be relied upon solely for

vehicle’s potential future trade-in value when considering the ability to make the balloon

payment, which may fall short at any point in time. For example, if during the time, the trade-in

value of a vehicle becomes less than the balloon amount, the difference will have to be paid to

the credit in such a case. To make this actually work, it requires a lot of planning and

consideration before execution.

Thus, Balloon financing can be a viable and great option to those looking for mechanisms like auto

financing. As with any other financial decision, it becomes important to research all options and

then consider the present dynamic situation. Balloon financing can and should be used after due

deliberation of its benefits and disadvantages, linking them to the needs of the investor, before

actually putting it to use.

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