Balloon Payments Demystified

Loans with balloon payments can be confusing. It’s not so much that the structure or calculations for them are complex. The confusion is because the Internet is loaded with blogs and articles that use varying terminology for them. In this post, I will try to sort this confusion out for you and explain some of the different loan payment schedules that AMCalc generates that can have a balloon payment.

What is a Balloon Payment?

First, what is meant by the term “balloon payment”? 

Simply put, a balloon payment is a loan payment that is significantly larger than other periodic payments on the loan.  Usually, the balloon payment is the last payment on the loan and completely pays off the remaining loan balance in one lump sum.  A loan with a balloon payment is sometimes also called a “bullet loan” or “bullet repayment”.

While a lot of blogs and articles talk of balloon payments as a type of loan, it is really just a characteristic of a loan.  The loan in question can be one of a few types.   If that is confusing, read on and hopefully it will become clearer.

Why have a Balloon Payment?

For both lenders and borrowers, there are reasons why a loan with a balloon payment may be beneficial. For borrowers, up until the point when the balloon payment comes due, the loan will typically have lower periodic payments than a loan without a balloon payment. So if the borrower expects to have an influx of cash in the future that can be used pay the balloon payment, this type of loan may suit them. For lenders, loans with balloon payments can help mitigate risk by getting back the loan principal earlier than otherwise.

Interest Only Loans

If you have read my post on interest only loans, you know that interest only loans can result in a balloon payment at the end of the loan.  In short, interest only loans have periodic payments that only pay the interest due on the loan’s principal.  The periods where only interest is paid can be for the full length of the loan, or for a portion of it.  Since none of the principal is being paid down in these periods, there will be a balloon payment required in order to pay back the loan’s principal at end of the loan. 

If you have not read the post on the different interest only loans that AMCalc calculates, I encourage you to do so because it goes into depth on how they are calculated. You can find that post here.

Amortized Loans with Balloon Payments

Another type of loan that can have a balloon payment is an amortized loan.  This is probably the more common loan type with a balloon payment.  Amortized loans, by definition, are calculated to have the same (fixed) payment amount for every period of the loan.  Each periodic fixed payment, unlike interest only loans, includes both a portion of the payment that pays down the loan principal and a portion that pays the interest owed for each period.

To understand how this type of loan works in regards to balloon payments, we need to define two terms; “loan amortization” and “loan term”.

To find a loan’s fixed payment amount, the AMCalc calculator uses the number of periods input into the Loan Amortization field, along with the loan principal, interest rate, start date of the loan, and other calculator inputs.  The end result is a loan payment schedule that has the same payment amount for every period of the loan.  Actually…not quite! Usually the last payment will very slightly from the rest of the payments.  This is due to the cumulative rounding to whole cents during the generation of the schedule.

So, “loan amortization” is the number of loan payment periods that are used by the calculator to find a fixed payment amount over the life of the loan.  But you may be wondering if the payment is the same for the entire loan, where is the balloon payment? 

This is where “loan term” comes in.  Loan term is the length of the loan.  Remember, I said amortized loans can have a balloon payment.   If the number in the loan amortization and loan term fields are equal, there will be a fixed payment throughout the life of the loan and no balloon payment.  If the loan amortization and loan term inputs are not equal, there will be a balloon payment at the end of the loan.

The AMCalc calculator always uses the loan amortization input into the calculator, and ignores the loan term, to find the fixed payment amount.  Once the fixed payment amount is determined, it is used on the payment schedule which will contain the payment periods indicated by the loan term input into the calculator.  On the last term period, if the principal is not completely paid off, the left over principal is added to the interest owed for the period, resulting in a balloon payment.

Examples of AMCalc Amortized Loans

Let’s see how this looks in the AMCalc calculator.

In this calculator, you can see that the Loan Amortization and Loan Term are both set to 20 years.

For this loan we are allowing it to be paid back in equal payments over 20 years. AMCalc will use the 20 years input into the Loan Amortization field to calculate a fixed payment amount for the life of the loan. The result will be a payment schedule with 240 payment periods (20 years x 12 months per year) with all 240 periods having the same fixed amount. Once the 240th payment is made, the loan is fully paid off.

Now take a look at the same calculator inputs, but with a Loan Term of 15 years. 

For this loan, we will have a fixed payment amount as if it is going to be paid back in 20 years, which allows for a lower monthly payment for the borrower, but we want the loan paid back in full in 15 years instead of 20.

As before, AMCalc will use the 20 years input into the Loan Amortization field to calculate a fixed payment amount.  

In this example, the fixed payment amount will be the exact same one calculated in the first example.  But this time the resulting payment schedule will have 180 payment periods (15 years x 12 months per year), instead of 240 in the previous example.  Payment periods 1 through 179 will have a payment amount due that is equal to the fixed payment amount, but payment 180 will be a balloon payment.  This balloon payment will be equal to the interest due in period 180 plus the full remaining principal of the loan.

To learn more about AMCalc, the loan payment schedule generator for Salesforce, go to the Salesforce AppExchange. You can see the calculator in action by clicking the Demo button or you can download the app to your Salesforce system and try it for free for 7 days.

If you have any questions or comments about this post, add a comment below and I will do my best to respond. Thank you for reading!