When it comes to taking out a loan, two popular options are balloon payment loans and traditional instalment loans. But what exactly is the difference between balloon loan and regular loan, and which one is better suited to your needs? This blog breaks down the key differences between balloon payment loans vs traditional loans to help you make an informed decision.

What is a Balloon Loan?

A balloon loan offers low monthly repayments, but the final payment (known as the "balloon payment") is much larger than the rest. This type of loan allows borrowers to afford the monthly repayments, with the aim of paying off the large final payment by refinancing or selling the asset purchased.

Key Features:

• Repayments: Low monthly repayments followed by a large final "balloon" payment

• Usage: Typically used to purchase assets like cars, equipment, or property

• Interest: Interest rates are usually higher than fixed-rate loans

• Term: The loan term is usually shorter (e.g. 5 years instead of 15 years)

Benefits for Borrowers:

• Cashflow: Lower monthly repayments free up cash flow

• Opportunity: Opportunity to purchase more expensive assets you couldn't otherwise afford

• Flexibility: Flexible loan structure

Disadvantages:

• Cost: Higher interest rates increase the total cost of the loan over the loan term

• Risk: Risk of not being able to refinance or afford the final payment

• Equity: Possibility of negative equity if asset value drops

What is a Traditional Instalment Loan?

A traditional instalment loan has equal monthly loan repayments spread evenly over the full loan term. The payments are structured to pay back both the principal (loan amount) and interest over the duration of the loan.

Key Features:

• Payments: Fixed regular monthly payments with interest and principal included

• Purpose: Used for almost any borrowing purpose (car loans, mortgages, personal loans, etc.)

• Rate: Usually has lower interest rates than a balloon loan

Benefits for Borrowers:

• Budgeting: Predictable even payments make budgeting easier

• Savings: Lower interest rates reduce the total cost over the loan period

• Equity: Building equity in an asset with payments

Disadvantages:

• Cashflow: Larger monthly repayments can tie up more of the monthly cash flow

• Duration: Longer loan terms mean paying more total interest

Balloon Payment Loans vs Traditional Loans: Which Option is Right for You?

So when trying to compare balloon and traditional loans, consider your financial situation and priorities:

• Flexibility: This structure offers more short-term flexibility if you want to minimise monthly payments and have a plan to pay off the final balloon payment.

• Stability: A traditional principal and interest loan may be preferable if you value predictable payments and total cost savings.

Use Cases and Examples

Balloon Loans

Neha takes out an ₹11 lakh balloon loan to purchase a used car. The loan has manageable monthly repayments of ₹18,000 and a final payment of ₹3.5 lakhs due in 5 years when the loan period ends. She plans to trade in the car and use its value to cover the final payment.

Rohan used a balloon loan to buy expensive new machinery for his business worth ₹75 lakhs. The monthly repayments were affordable for the business's cash flow, and the balloon payment matched a tax refund he was expecting to receive at the end of the 5-year term.

Traditional Instalment Loans

Prateek took out a 20-year traditional home loan for his first apartment. He will make even principal and interest repayments every month for the next 20 years, paying off the full purchase price by the end of the loan.

Priya found a great low rate on a personal loan for home renovations. She will pay off the ₹15 lakh loan over 7 years with fixed monthly payments of ₹14,000.

The Bottom Line

Balloon payment loans can help you purchase more expensive assets with lower monthly payments, but they do carry higher risk and costs. Traditional instalment loans from financial instituitions such as Shriram Finance offer predictable payments with lower rates but smaller loan amounts and longer terms. So assess your priorities, future plans and financial situation to choose the loan structure that fits you best.

FAQs

What is the main difference between a balloon loan and a traditional loan?

The main difference is that a balloon loan offers low monthly payments with a large final "balloon" payment, while a traditional loan has even principal and interest payments spread over its full term.

Which loan type offers lower monthly payments?

Balloon loans offer lower monthly payments, making them more affordable each month. But you take on the risk of being able to afford the final balloon payment.

Are balloon loans riskier than traditional loans?

Yes, balloon loans for cars and mortgages carry higher risk because if you're unable to refinance or cover the large final payment, you can default on the loan and lose the asset.

Is it easier to qualify for a traditional loan?

Often yes, because traditional loans pose less risk for lenders thanks to the predictable payment structure. Balloon loan qualification can be more stringent.

What happens if I can’t pay the balloon payment?

If you can't pay off the balloon payment, you face the risk of default. This means potentially losing the car/home/asset purchased with the loan.

Which loan type is better for long-term ownership?

Traditional loans are better for long-term ownership as they steadily build equity and are fully paid off by the end of the loan term.

Can I refinance a balloon loan into a traditional loan?

Yes, it is possible to refinance a balloon loan into a fixed-payment, fully amortised traditional loan when the balloon payment is due.

How do balloon and traditional loans compare in total cost?

Overall, traditional loans tend to be lower in total cost because they carry lower interest rates over the life of the loan. Balloon loans cost more in the long run.