Balloon Loans
A balloon payment loan has a fixed date to maturity, usually three to ten years, but it doesn't fully amortize (pay down to zero) over the term of the loan. Instead, it leaves the rest of the balance due at maturity. The term balloon payment refers to the large remaining size of the payment at the end of the loan. A balloon loan may be set to amortize over thirty years and typically carries a fixed rate.
Why would a borrower choose a balloon loan over a fixed-rate loan? This is another case in which the lender is sharing more risk with the borrower, so the lender will reward the borrower with a lower rate or slightly better terms than a fixed-rate term.
What's the incentive for the lender? Borrowers almost never get to the point where they make the balloon payment. They're likely to refinance first, and if they keep the same lender, the lender gets to capture all the fees when they do that.
Make sure that if you take on a balloon loan of any kind you have the ability to prepay the loan or to refinance at some point before the entire principal balance is due. If the lender hesitates on this point or you don't see language in your loan agreement that guarantees this, walk away.
One thing about refinancing a balloon loan, as in refinancing any loan, is that you have to keep your payment record absolutely spotless. Your current lender doesn't have an incentive to refinance your loan at attractive rates if you don't, though you might be able to find a new loan elsewhere.
