Balloon payments refer to very large payments at the end of some short-term loans called balloon loans. Balloon loans are used in commercial settings and sometimes for personal loans, but since the balloon payment often is more than twice the regular payments, individuals rarely receive balloon loans. These loans usually begin with a fixed interest rate for the set loan period. Often, the loan will be refinanced before the balloon payment is due which usually results in a different interest rate. This is in contrast with adjustable rate loans and mortgages which automatically change interest rates after a certain time period, without refinancing or a balloon payment.
Balloon loans can be financially hazardous especially for real estate because the value of the collateral may drop after entering the loan. This may prevent the debtor from being able to refinance the loan before the balloon payment is due because the collateral no longer financially supports the loan. Balloon loans have been questioned by many regulators as it often allows creditors to give loans to debtors who cannot afford the final payment and avoid the level of financial standards for other loans. In response to many failed balloon loans, regulators changed Regulation Z of the Truth in Lending Act in 2008 to require creditors to ensure that the debtor has enough resources besides the collateral of the loan to repay or refinance the loan. Creditors do not have to meet these new requirements for balloon loans with a period of 7 years or longer.
[Last updated in December of 2021 by the Wex Definitions Team]