How Does a Balloon Payment Work?

Balloon loans allow smaller Equated Monthly Instalments (EMIs), but the borrower must have plans ready to pay the large balloon amount when the loan matures. Otherwise, it can result in financial stress. Here is how it works:

• Balloon loans allow borrowers to make lower EMIs during the loan period by deferring a portion of the principal to the end.
• For example, if a loan of ₹20 lakhs is to be repaid over 10 years, the EMI would be around ₹24,000. With a balloon payment structure, the EMI could be reduced to ₹18,000 and a balloon payment of ₹5 lakhs at year-end.
• The deferred principal amount is the balloon payment. It is usually 25-50% of the total loan amount. To fully close the loan, the borrower must pay this large payment when the loan matures.
• These loans are suitable when the borrower is facing temporary cash flow issues but expect higher income in the future or if the asset is going to be sold before loan closure.
• Balloon loans carry higher risk as the borrower needs to have the full balloon amount ready at maturity. If the borrower is unable to pay, default or foreclosure can occur.
• Lending institutions may allow refinancing the balloon payment into a new loan at maturity, but that leads to elongated debt and higher overall interest outgo.
• Balloon loans are common for commercial financing situations like real estate or equipment purchases. Banks may also offer these for home/car loans at higher interest rates and with precautions.