Balloon Payment

Meaning and Definition

A balloon payment is a large lump-sum payment that is due at the end of a finance agreement, typically associated with certain types of loans, such as balloon payment loans or lease agreements. It is a way to defer a portion of the total cost to the end of the agreement, resulting in lower monthly payments during the term.

Why it is important to know

Balloon payments allow borrowers to have more affordable monthly payments during the loan term, as a significant portion of the principal amount is deferred to the end. However, borrowers need to be prepared to make the balloon payment when it becomes due or consider alternative options, such as refinancing or selling the vehicle, to settle the remaining amount.

Example in car finance

Suppose a borrower enters into a car finance agreement with a balloon payment option. The agreement specifies regular monthly payments for a fixed term, such as three years. At the end of the term, the borrower has the choice to either make the balloon payment, which represents the remaining balance on the loan, or refinance the amount or sell the vehicle to cover the outstanding amount. The balloon payment allows the borrower to have lower monthly payments throughout the agreement term but requires careful financial planning to handle the final payment.